Tax avoidance and wealth offshore have become leading news stories in recent weeks.  Time will tell what, if any, effect the Panama Papers leak will have.  Further challenges have been made against schemes based on investments in the film industries made in the 1990s.  Not unnaturally, when tax avoidance schemes fail, taxpayers will look to the advisors who advised them to enter the schemes.

The recent judgment in Barker v Baxendale Walker Solicitors & Baxendale-Walker [2016] EWHC 664 (Ch) is a useful case study providing valuable lessons for practitioners.  In particular it addresses whether a solicitor advising on statutory interpretation will be negligent for failing to warn that his opinion could be wrong.

Background

The claimant, who had developed a successful management consultancy and software business during the 1990s, decided to sell the business.  He wanted to minimise the capital gains tax (“CGT”) payable on the sale of his shares.  His tax advisers suggested an employees benefits trusts (“EBT”), as defined by section 86 of the Inheritance Tax Act 1984 (“IHTA”), and referred him to the defendant.  (The firm and leading partner are collectively referred to as the defendant in this article.)

The defendant advised the claimant that an EBT would permit him to avoid paying CGT on the sale.  The key advice – later alleged to be negligent – was that the claimant’s family would be able to benefit from the EBT after his death.  The accuracy of that advice depended on whether the EBT also satisfied the requirements of section 28 IHTA.

The Scheme

The claimant retained the defendant on 2 October 1998.  (There was no argument over the scope of the retainer.)  On 6 October 1998, the claimant’s business settled an EBT and appointed an offshore trustee. 

The beneficiaries of the EBT were defined as the employees of the business and their families, together with exclusions designed to satisfy the requirement of section 28 IHTA.   An offshore investment company was established to receive UK income and property was purchased.  On 23 March 1999 the trustee declared a sub-trust in favour of the claimant’s family so that his contribution would be ring fenced. 

On 15 October 1998 the claimant declared that he held his shares in the business on trust for the EBT.  If this gift satisfied section 28 IHTA, then no CGT would be payable.  Because the trustee was based offshore, no CGT would be payable on sale.  Assets held in a discretionary trust are generally taxed in accordance with sections 64 and 65 IHTA but this does not apply to EBTs and investments made by the EBT were tax exempt.  Further, the claimant would be able to take deep discount, commercial loans from the trust, with the loans and interest being rolled over – on the claimant’s death the loan became a debt of the estate, thereby reducing inheritance tax (“IHT”).   Upon the claimant’s death, his family would become full beneficiaries under the trust and so could then receive contributions.

The fees charged (by the defendant and others) for setting up the scheme came to an astronomical £2.5m.

The shares in the business were sold on 28 June 1999.   As part of the deal the claimant received about £12m in cash and shares in the purchaser and around £5.8m went into the sub-trust.  The claimant had therefore received sufficient cash from the sale that he would not need to access the assets in the EBT in his lifetime.

HMRC’s investigation

In August 2005 HMRC informed the claimant that they would be investigating the sale, specifically whether any CGT should have been paid.  The initial problem was that members of the claimant’s family appeared to have been benefitting from the property owned by the EBT. 

After a significant hiatus, HMRC wrote to the claimant on 19 March 2010 to advise him that they intended to make assessments.  Only at this stage did the contention surface that section 28 IHTA was not satisfied because the claimant’s family would be able to benefit after his death.   The claimant appealed against this decision on 16 February 2011.  For the first time on 4 July 2012, one of the claimant’s advisers advised that there were strong arguments in favour of HMRC’s contention.  On advice, the claimant settled the matter in April 2013 with HMRC for the sum of around £11m.  At this time it was estimated that the trust might be worth around £35m.

The claim

The claimant’s claim was brought on two grounds:  first, that the advice that the claimant’s family could benefit from the EBT after his death was negligently wrong; alternatively, that the defendant failed to warn the claimant of the risk that his family might need to be excluded even after his death, in which case he would have used a different, less risky, scheme and avoided the loss.

The decision

Mr Justice Roth considered section 28 IHTA.  Subsection (1) provides for a transfer to an EBT to be exempt.  Subsection (4) prevents the exemption from applying “if the trusts permit any of the settled property to be applied at any time … for the benefit of – … (d) any person who is connected with [a participator in the company].”  It was common ground that the claimant’s family were connected persons during his lifetime but not after his death.  The question was whether section 28 prevented the EBT making payments to a person who was a connected person at the time of the transfer of value into the trust (which would preclude the claimant’s family completely) or at the point of payment (which would not prevent payments being made after his death). 

The judge held that the former interpretation, i.e. that which the claimant contended for, was very doubtful.  (He relied particularly on the fact that the claimant’s interpretation required the court to imply words into the statute, which was to be avoided unless the alternative was absurd.)  Accordingly he found that it was not negligent for a reasonably competent tax specialist to take the view that the defendant did and so the claimant’s primary case failed.

The alternative case required consideration of the question whether a lawyer exercising appropriate skill and care ought to warn that his preferred interpretation might well be wrong.  Various authorities were put before the court:  Dixey & Sons v Parsons (1964) 192 EG 197; Queen Elizabeth’s Grammar School Blackburn v Banks Wilson [2001] EWCA Civ 1360; [2002] PNLR 14; Hermann v Withers [2012] EWHC 1492 (Ch); [2012] PNLR 28; Levicom International Holdings v Linklaters [2010] EWCA Civ 494; [2010] PNLR 29.   The judge suggested that the need to warn is greater where the lawyer is advising before a client embarks on a course of action and where the lawyer is already on notice as to the possible point of challenge to his preferred interpretation.

The defendant’s advice in relation to the EBT scheme was certainly bullish and subject to no real qualification at all.  For example, when shown advice from another firm of solicitors that contrasted with his own, the defendant theatrically threw the advice over his shoulder and likened the other firm to general surgeons compared with brain surgeons.  The judge held that the defendant was in breach in failing to give a generic “general health warning” of the possibility of challenge by HMRC.  However, as a matter of causation this was insufficient – a mere general health warning would not have deterred the claimant from entering into the scheme. 

To succeed on causation, the claimant required a finding that the defendant had negligently to failed to give a specific “high level warning:” that there was a risk that an EBT which did not exclude persons connected with the participator even after his death would not qualify for tax relief.  The judge accepted that the claimant would not have continued with the scheme if given such a warning. 

The judge accepted that a solicitor who comes to a non-negligently incorrect view might be negligent for failing to give a warning.  But he found “it difficult to see that solicitors whose interpretation is likely to be correct [i.e. where argument was not finely balanced] are nonetheless in breach of duty for failing to warn the client that they might be wrong.”  He therefore rejected the claimant’s alternative case.

Discussion

This case demonstrates that even long dormant arrangements from the 1990s can be subject to challenge by HMRC.

This decision is helpful for defendants in professional negligence cases.  It lessens the chance that a lawyer will be held negligent for giving correct advice while leaving the door open for claims relating to non-negligently wrong advice.  It reduces the scope for claimants’ lawyers to advance an alternative case that, in effect, increases the duties imposed by common law.  It is also useful warning to claimants of the risks of bringing a case on breach that has been reverse engineered from the case on causation.  Such an approach often leads to artificial allegations of breach.  

The judgment is notable for two other points.  On limitation, the judge found that the date of knowledge under section 14A Limitation Act 1980 was the date of the specific contention by HMRC relating to section 28 IHTA and/or the advice that the contention might have merit.  Both of these dates were in time for a claim issued on 10 April 2013.  

On damage, the judge found that the claimant’s alternative option of using a different scheme was subject to reduction on the basis of a loss of a chance – because the success or otherwise depended on matters independent of the parties (largely HMRC’s response to the other scheme) – to 70 per cent of the total claimed.