Court unwinds trust on basis of settlor’s mistake

In the recent case of Der Merwe v Goldman & Ors, 2016 EWHC 790 Ch, the Court in England & Wales has agreed to unwind a trust arrangement set up by the settlors after they transferred their home into a trust a few days after the changes to the IHT treatment of trusts were introduced in the budget on 22 March 2006.

Philip Van Der Merwe and Deborah Goldman, both of whom were considered non-UK domiciled at the date of the creation of the settlement and the date of the transfer of the property into trust, executed the relevant documents on 24 and 27 March 2006. At that time they were unaware of the changes announced in the budget on 22 March.

Prior to the changes the placing of the house into a trust under which the settlor had an interest in possession, at a time when the settlor was non-UK domiciled for IHT purposes, provided the couple with an IHT advantage. The transfer of property into such a trust would not have given rise to an IHT charge as the settlor would have been treated as remaining beneficially entitled to the trust property by virtue of section 49(1) IHTA 1984.

However, following the changes on 22 March 2006, the Finance Act 2006 made this type of transaction liable to an immediate IHT entry charge. In addition, the trust fell within the relevant property regime for IHT and was therefore subject to the 10 year anniversary and exit charges.

Although the settlors had sought professional advice in November 2005 the fact that the documentation was not executed until after the changes meant that the trust fund was dealt with under the new regime for trusts. As a result, an entry charge of approximately £200,000 arose on the transfer to the trust, as well as a 10th anniversary charge of approximately £120,000 on 27 March 2016.

Since the settlor did not become aware of the IHT implications until August 2012, he failed to declare the initial gift for IHT purposes and interest and penalties of approximately £60,000 therefore also arose.

Based on the facts presented the Court accepted that, had Mr Van der Merwe been aware of the changes announced in the 2006 Budget, he would not have continued with planning of this nature after that date. Therefore, taking into account the relevant legal principles pertaining to gifts made as the result of a mistake as recently defined in Pitt v Holt 2013, the trust was set aside on those grounds.

The Court’s approach in this instance should not be seen to open the floodgates in respect of rescission cases where ignorance of the law has led to a wrong assumption about the tax consequences of a transaction. The claimant’s success in this case relied upon the fact that he believed there to be no question of a charge to tax by reason of his actions rather than a mistake that involved running a risk about a possible liability to pay tax.

There is a distinct difference and the Court will no doubt take a less kindly approach with any applications for transactions to be overturned where the intention was to avoid tax.