The Court of Appeal recently found that solicitors were negligent in not giving a specific warning that their interpretation of the legislative basis for a tax avoidance scheme might be wrong.
FactsIn 1998 Baxendale-Walker Solicitors (“BWS”) gave specialist tax advice to a businessman, Mr Iain Barker, about a tax avoidance scheme designed to avoid both CGT and IHT on the sale of his shares in a company of which he was the majority shareholder. At that time the company was considered to be worth between £30 million and £40 million. The scheme involved the establishment of an employee benefit trust (“EBT”) offshore, the transfer of company shares by gift to the EBT and the creation of a sub-trust with members of Mr Barker’s family as beneficiaries, who could only benefit after his death.
In order for the EBT to achieve the intended tax advantages, it was crucial that a particular interpretation of section 28(4) Inheritance Tax Act 1984 (“IHTA”) prevailed. This concerned the date on which the question of Mr Barker’s family members’ connection to him fell to be considered. BWS’s view was that it fell to be considered at the time that the benefits were applied, which would mean that the family members would be able to take benefits free of tax after Mr Barker’s death. BWS did not warn Mr Barker that there was a significant risk of an alternative interpretation of section 28(4) such that the date at which the connection of the family members fell to be considered was the date on which assets were transferred into the EBT. This would mean that the family members would not receive tax free benefits after his death. The Court of Appeal referred to this interpretation as “the post-death exclusion construction”.
HMRC challenged the EBT scheme more than 10 years later on the basis of thepost-death exclusion construction. Following advice that the challenge would probably succeed, Mr Barker entered into a settlement with HMRC under which he paid more than £11million in tax and interest. He then claimed damages from BWS for alleged negligence.
At first instance the Judge held that BWS were in breach of duty in not having given a general warning that the tax avoidance scheme could be challenged successfully by HMRC, but found that any such warning would not have deterred Mr Barker. He held that a specific warning of the risk of the post-death exclusion construction would have deterred Mr Barker but that this was not a case in which any careful and competent solicitor would have given such a warning.
AppealOn appeal, Mr Barker contended that BWS should have given a specific warning that there was a significant risk that the EBT would fail to be tax effective because of the post-death exclusion construction. It was not alleged that BWS’s view of the construction of section 28(4) IHTA was negligent.
The Court of Appeal considered that, as part of the legal advice being provided, the lawyer must evaluate the legal position and advise the client that there is a significant risk that the view he has taken about the matter in question might be wrong. In this case the relevant facts included that this was a “very aggressive tax avoidance scheme”. The Court described the intention that Mr Barker’s family would be able to benefit from property within the EBT at his death free of CGT and IHT as “an outcome which might appear on the face of it to be too good to be true”. Further relevant facts were that the potential charge to tax was very large and that BWS’s fee was in the region of £2.4m.
The appeal succeeded. Lady Justice Asplin held that “there was a significant risk that the EBT arrangement would not work as a result of the post-death exclusion construction which was centrally important to its structure and the likelihood that the promised tax advantages would be delivered” and that in those circumstances BWS should have given a specific warning. She concluded that “there was a significant risk that their advice was wrong and in all the circumstances, a reasonably competent solicitor would have gone beyond his own view and set out the risks”.
Points for Practitioners
It is unsurprising that the Court found that solicitors should advise their client of the risk of pursuing a course of action designed to avoid a substantial tax bill.
This case highlights the fact that the question of when solicitors have a duty to warn of the risk that their interpretation of the law is wrong is highly fact sensitive. It demonstrates the importance of context including the level of fees charged by the solicitors, the likelihood of their view being challenged and, in relation to tax avoidance, the amount of tax potentially payable and the purpose of the relevant tax legislation.