£200,000 Capital Gain Sidestepped by Farmers Through Rescission

The High Court has found that transfers into trust which had triggered disastrous and apparently unexpected tax consequences could be rescinded for mistake using equitable tracing.

A father and son who farmed in partnership had transferred several pieces of land into a discretionary trust without realising that the transfers would lead to a substantial capital gains tax charge. They successfully applied for rescission of the transfer on the grounds of mistake, applying the principle in Pitt v Holt [2013].

The reasons for setting up the trust were to protect the land from potential claims from third parties including possible claims from the other children of the father on his death, and a possible claim from the son’s wife on divorce. How the trust was set up appears to be quite opaque however, It is also unclear as to why the £200,000 capital gain was not held over under TCGA 1992 s 260. The partners then solicitor was not a party to the claim.

They applied for rescission of the transfer on the grounds of mistake, applying the principle in Pitt v Holt [2013] 2 AC 108.

The High Court granted the relief sought in respect of the land which remained in the trust.

The trust had sold some of the land and part of the proceeds had been used to acquire other land. The claimants accepted that the buyers had bought in good faith so that the sales could not be rescinded, but they argued that the court should make an order restoring the new land to the owners of the original properties. The High Court agreed that the consequence of rescission was the same whether it took place because of fraudulent (or negligent) misrepresentation, or because of mistake. The property transferred must be vested back to the transferors unless third party rights were involved. Where third party rights cannot be disturbed, there is no reason not to apply a tracing process to exchange products of the transferred property in order to find other assets to which to apply the claim instead.

As to the tax consequences of rescission, the court held that once the transfers into the trust were treated as never having happened, the sales (actually by the trustees) should be imputed to the original owners. It also held that this applied to the use of the proceeds (in part) to invest in the new land (for roll-over relief purposes) and (in part) to pay stamp duty.

By accepting to apply a tracing process, whereby the original owners were deemed to have sold the land (as opposed to the trustees), the High Court made a roll-over relief claim possible for the original owners.

For those who like a good read try T and C Bainbridge v P Bainbridge [2016] EWHC 898 – http://goo.gl/pyYBQH