The High Court has allowed a clause in a deed of appointment to be set aside on grounds of mistake – the mistake related to the inclusion of certain assets, which did not qualify for relief from Capital Gains tax (CGT), resulting in unexpected CGT liability.
The trustees of the settlement were the settlor, Brian George Kennedy, his wife, and their solicitor. Under the terms of the settlement, Mr Kennedy had a life interest in possession in the assets of the settlement. The settlement provided for the trustees to have a power of appointment, ( i.e. to decide who should benefit from the trust) which could be exercised in favour of Mr Kennedy and his children (among others). In default of the exercise of the power of appointment, the capital was to be held on trust for the Kennedy' s children.
The Finance Act 2006 introduced new rules for settled property. To mitigate adverse tax consequences resulting under the new regime, trustees and beneficiaries could, for a transitional period, reorganise existing trusts in various ways. Mr Kennedy was advised that under these provisions, he could appoint assets to himself and make dispositions in favour of his children, which would have the effect of reducing his future inheritance tax liability.
While Mr Kennedy's solicitor was out of the office for a major operation, it was agreed with his accountant that certain shares should be excluded from the appointment, as they did not qualify for holdover relief for the purposes of capital gains tax ("CGT"). It was also agreed that certain losses that had been made on shares in a company, Celuform should be used in the 2007-2008 tax year to offset the gain on the sale of other shares.
In October 2008, Mr Kennedy his wife and his solicitor signed a deed providing for cash to be held on protective trusts for Mr Kennedy's five children. Clause 2.1(c) of the deed provided that the remainder of the assets should be appointed on trust for Mr Kennedy absolutely. Clause 2.1(c) listed the remainder of assets, and included the shares that were to be excluded from the appointment. The effect of the mistake was to generate an unintended CGT liability of approximately £650,000.
Findings on rectification
One of the reliefs sought by the trustees was rectification of the deed. The Chancellor held that rectification could not be permitted, as Clause 2.1(c) did in fact represent the intention of the solicitor drafting the deed. The solicitor's intention (as opposed to his motive) was to include the wording in Clause 2.1(c); his mistake was in thinking that this was in accordance with Mr Kennedy's instructions, and that there were considerable tax losses in the settlement which would preclude any charge to CGT as a result of the transfer of the shares. These matters were extraneous to the document, and did not amount to a mistake which could found a claim for rectification.
Findings on mistake
The Chancellor followed the decision of the High Court in Pitt v Holt UKSC 26 and held that the voluntary disposition was voidable under the equitable principle of mistake. The mistake made by the trustees was both "causative and very serious". With respect to causation, he noted that Mr Kennedy had executed the appointment in the mistaken belief that it gave effect to his intention (discussed and agreed with KPMG) that the relevant shares would remain in the settlement to avoid any charge on them to CGT . Mrs Kennedy had understood that the October 2008 appointment was a tax-efficient way of benefitting her children, and that it gave effect to Mr Kennedy's intention and instructions to his solicitors. Finally, the solicitor had been under the misapprehension that (a) the loss on the Celuform shares was available to offset any gains on assets, for CGT purposes, and (b) that the October 2008 appointment gave effect to the instructions of Mr Kennedy.
As to the seriousness of the mistake, the Chancellor noted that it was a "fundamental feature" of the appointment that it should not give rise to a charge to CGT. In addition, the effect of clause 2.1(c) was to deprive the other beneficiaries of the settlement of the relevant assets, as well as diminishing the value of the remaining assets by the CGT charge.
The Court further held that this was not a case of "artificial tax avoidance", as mentioned by Lord Walker in Pitt v Holt. The trustees in this case had not accepted the risk that the scheme would prove ineffective. This was a "perfectly legitimate" way of conferring benefit on Mr and Mrs Kennedy's children and grandchildren. Taken in the round, this made it unconscionable to leave the October 2008 appointment uncorrected.
While there was authority that there could not be partial rescission of a contract (De Moelstine v Ponton  1 LL Rep 70), the Chancellor could see "no reason why that limitation should apply to a self-contained and severable part of a non-contractual voluntary transaction". It was therefore held that only clause 2.1(c) was rescinded.
The decision is notable for the liberal approach taken to unwinding mistakes made as to the tax consequences of trustees' actions. In Pitt v Holt, Lord Walker stated that “in some cases of artificial tax avoidance the court might think it right to refuse relief, either on the ground that such claimants, acting on supposedly expert advice, must be taken to have accepted the risk that the scheme would prove ineffective, or on the ground that discretionary relief should be refused on grounds of public policy.” The Chancellor acknowledged this in this case but held that this was not an “artificial tax avoidance arrangement” but “a perfectly legitimate way of conferring benefit on Mr and Mrs Kennedy’s children and grandchildren in a tax efficient manner that was contemplated by express provisions in FA 2006". While the arrangement may not have been "artificial", allowing rescission on the basis of Mrs Kennedy's mistake in particular marks a particularly permissive approach. Her mistake was that she believed the October 2008 Appointment was a "tax efficient method of benefiting her children" (and in accordance with her husband's instructions).
This approach taken to mistake in this case may well reflect the fact that this was a private client case (as was the case in Pitt v Holt). In particular, the question of whether it would be "unconscionable" not to allow rescission for mistake may be answered differently in another context, such as in the case of a mistake made in a deed relating to an occupational pension scheme.
Brian George Kennedy & Ors v Patrick Brian Kennedy & Ors EWHC 4129 (Ch)