Fieldfisher Secures Rescission of EBT Sub-Trusts, Avoiding c.£7M Tax Risk

Fieldfisher acted for the successful claimants, and is uniquely placed to deal with such cases given the trust, tax, and trust and tax litigation expertise across its Private Client, Employee Benefit Trust (Employee Equity Incentives), Tax Litigation, and Trust Litigation departments.    

The court approved the claim because the sub-trusts were created on the basis of a mistake by the relevant trustees as to the tax consequences of the relevant appointments.  

The judgment (see here) provides a framework for trustees seeking relief where (i) sub-trusts have been created within an Employee Benefit Trust (i.e., where funds have been allocated to particular beneficiaries), (ii) the relevant trustees created such sub-trusts on the basis of a mistake as to the potential tax consequences, and (iii) a risk of a liability to inheritance tax has arisen.  

An opportunity therefore arises on the back of the judgment for other trustees to remove potential liabilities to inheritance tax where assets within an Employee Benefit Trust have been allocated to specific employees in a particular way.  

Background 

Two Employee Benefit Trusts ("EBTs") were created for the benefit of employees of Janus Henderson, the asset management group - the "HFBT" in 2005, and the "EFRBS" in 2011. 

Subsequently, the trustees of the HFBT and EFRBS created, in essence, certain sub-trusts. The sub-trusts in simple terms created 'pots' for individual beneficiaries and their families:  

• For the HFBT, a deed of appointment was executed whereby the trustee declared a specific part of the trust fund was held for a particular beneficiary and their family members only [12].    

• For the EFRBS, the trustee exercised a power to appoint specific assets to "Members' Accounts", for the benefit of certain beneficiaries and their family members only [17].  

The Law 

EBTs benefit from an exemption in s.86(1) of the Inheritance Tax Act 1984 (the "IHT Act"), which provides that where property is held on trusts which can only benefit employees (or persons married to or dependent on such employees), such a trust falls outside the relevant property regime for the purposes of the IHT Act. This applies only if the persons who can benefit comprise 'all or most' of the persons employed by or holding office within the body concerned.  

The effect of this exemption is that such a trust is not subject to periodic charges to inheritance tax at ten-year anniversaries, or exit charges on property ceasing to be subject to the trust [23].  

The issue with the creation of the sub-trusts was, therefore, that certain property in the trusts was not held for 'all or most' of the relevant employees, but instead for specific beneficiaries only.  

HMRC guidance on this point (published in 2012, after the appointments on to sub-trusts had taken effect) stated that "if the sub-trust only benefits an individual and their family it is unlikely to satisfy s.86…Where sub trusts are for the benefit of a named individual and their family, it cannot be said that the settled property (i.e., the assets in that sub trust) are being held for the benefit of all or most of the employees at that time, so s.86 will not apply". In light of this guidance, there was a clear risk that HMRC would assert that the assets within the sub-trusts did not benefit from the exemption in s.86.  

The claim 

In light of the above risk, the Claimants (being the relevant trustees and the company which settled the relevant assets on trust) issued a claim for the rescission of the sub-trusts on the grounds of mistake.  

The defendants were a beneficiary of the HFBT, and a beneficiary of the EFRBS, who acted as representative beneficiaries under CPR19.8. They consented to the claim. HMRC was notified of the claim, but did not ask to be joined as a party.  

In terms of the evidence, the court was informed that no documents had been identified which indicated that anyone involved with the creation of the trusts considered that there was any risk that the exemption in s.86 of the IHT Act would not apply to the assets of the trusts, including the sub-trusts. Evidence was also submitted noting that Janus Henderson were not 'aggressive tax planners' and would not have done anything that was considered 'dodgy or risky'. It was put to the court that it was 'ingrained' in Janus Henderson's thinking that they were setting up an EBT and that the s.86 exemption would apply. It was said that if any risk had been appreciated, the sub-trusts would probably not have been used.  

As for the defendants, they told the court in evidence that they were unaware of any risk of inheritance tax applying.  

The court was also referred to a number of historic documents which indicated that it was assumed that s.86 would apply to the trusts.  

HMRC did not ask to be joined to the claim, and so did not submit evidence.  It did however submit a letter to the court, suggesting that the appointment on to the sub-trusts resulted in the conditions of s.86 no longer being satisfied.  

The test for rescission on the basis of mistake 

The court explained that the test for rescission was as set out in Pitt v Holt [2013] 2 AC 108, and in Kennedy v Kennedy [2014] EWHC 4129 (Ch):  

(1) There must be a distinct mistake as distinguished from mere ignorance or inadvertence or a misprediction.  The court should be open to drawing the inference of conscious belief or tacit assumption when there is evidence to support such an inference.  

(2) A mistake may still be relevant even if it was due to carelessness on the part of the person making the disposition, unless the circumstances are such as to show that they deliberately ran the risk of being wrong.  

(3) The mistake must be sufficiently grave as to make it unconscionable on the part of the donee to retain the property.  

(4) The injustice or unfairness or leaving a mistake uncorrected must be evaluated objectively, to determine if it would be unconscionable to leave a mistake uncorrected.  

The court also noted that mistakes exclusively as to tax can be relieved by rescission, and tax consequences are relevant to the gravity of a mistake. It was further explained that an incorrect belief or false assumption about the tax effects of a disposition is capable of being the basis of a claim.  But no claim can be pursued where a Claimant is found to have deliberately run the risk of what has come to pass.  

The Court's judgment 

The court allowed the claim for rescission:  

• While the court was not asked to determine if HMRC were correct that the sub-trusts resulted in the exemption in s.86 falling away, it was enough to find that there was an incorrect or tacit assumption that there was no risk of a particular tax consequence, when in fact that real risk did exist [67]. The operative mistake was assuming that the sub trust assets would continue to benefit from the treatment in s.86 of the IHT Act [69]. There was no evidence that the sub-trusts represented risky or aggressive tax planning, and the trustees consciously considered that the relevant tax exemption applied.  

• The mistake was sufficiently grave – a liability of around £7m to tax could arise if the mistake was left uncorrected.  The trustees retained an insufficient sum to pay that tax, so there would be an issue as to where the tax was to be borne [72].  

• The mistake was sufficiently serious to render it unconscionable for the mistaken dispositions to be uncorrected. There was no reason why justice or fairness would require the appointment to remain in place, unless there was a general principle that the court should not intervene where the mistake has been as to tax effects, but that principle did not exist.  

As a result, the appointments on to the sub-trusts were unwound, such that the assets fell back into the 'head' trusts.  The assets would be 'informally' allocated to individual beneficiaries, but not held on trusts where only those beneficiaries could benefit. This was permissible and did not remove the benefit of s.86, not least because HMRC guidance indicated that the informal allocation of funds to beneficiaries would not cause the s.86 exemption to fall away [84].  

Comment 

The important take aways from the case are as follows:  

• Where assets within an EBT have been settled on to sub-trusts for particular beneficiaries only, or small groups of beneficiaries, there is a real risk that HMRC will argue that the s.86 exemption in the IHT Act will not apply and will assert that a tax event has occurred (see the HMRC guidance referred to above).  Accordingly, if sub-trusts have been used within EBTs, trustees should seek advice on the terms of the relevant deed and consider whether an application for rescission on the grounds of mistake should be brought at an early stage. Trustees should bear in mind that in most cases no IHT return will have been provided to HMRC (the trustees and employing company having not considered that a chargeable event has occurred) and so HMRC will have 20 years to recover lost tax. Time is therefore little bar to HMRC recovering significant sums (including the unpaid tax but also interest, currently 8.5%p.a., and penalties, which can reach up to 200% of the tax where trustees are resident offshore) 

• It is not necessary for the conclusion to be reached that a tax charge has arisen in such claims – what is required is evidence that there was an incorrect or tacit assumption that there was no risk of a particular tax consequence, when in fact that real risk did exist.  This provides for a route to a remedy in respect of an anticipated risk, in advance of any formal finding that a tax charge has arisen.  

• In trusts with a large number of beneficiaries, a single beneficiary representing each relevant class may be used as a representative beneficiary under CPRr19.8, reducing costs and complexity (subject to that person having no conflict in relation to the other members of the class they represent).  

• Evidence is crucial – the court will wish to see evidence that the relevant tax planning was not aggressive or that a risk was deliberately run (see comments at [71]), and that the trustees consciously considered that the relevant tax exemption applied (see comments at [70]).   

Fieldfisher acted for the successful claimants in this claim. For further information on this decision and Fieldfisher’s trust and tax litigation services, please contact Alistair Robertson or Joseph de Lacey.