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Trusts - Court Relieves Family of Severe Tax Consequences of Drafting Error

Trusts are delicate and often complex legal instruments and any flaws in the wording of documents relating to them can have grave tax and other consequences. As a High Court case showed, however, inadvertent drafting errors can be corrected.

The case concerned two trusts of which a widow and her son, her only child, were trustees and beneficiaries. They contained assets worth over £700,000, including a half share in the widow's home. By deeds of appointment, the son was granted life interests in both trust funds. The effect was that the funds were held on trust for him during his lifetime, with anything left over on his death passing to his children.

The fact that the son was unmarried and had no offspring gave cause for concern in that, if he died before his mother without leaving a widow or children, the trust funds would revert to his mother. If that happened, Inheritance Tax (IHT) would be payable on the funds when the son died and again when the mother died.

In order to avoid that risk, further deeds of appointment were drafted with a view to adding default beneficiaries of the trusts, including the son's five cousins. Due to a drafting error, however, the deeds had the inadvertent effect of terminating the son's existing life interests in possession and appointing new ones in their place.

The tax consequences of the error were extremely serious: amongst other things, it gave rise to an immediate potential charge to IHT of more than £80,000, with further IHT liabilities arising every 10 years. The son would also be treated as having made a gift with reservation of the underlying property in the funds so that, for so long as he remained interested in them, they would fall into his estate for IHT purposes in the event of his death. In those circumstances, the son launched proceedings with a view to putting right the error.

Ruling on the matter, the Court noted that the mother and the cousins all supported the son's claim on the basis that the funds would otherwise be severely depleted by tax liabilities. HM Revenue and Customs alone would be prejudiced by the grant of the relief sought but had chosen to play no active part in the proceedings.

The Court found that the drafting of the deeds of appointment was clearly flawed. The termination and reappointing of the son's life interests had a legal effect that was neither intended, wanted nor needed. The intention had not been to affect the son's interests in any way but merely to appoint default beneficiaries. The Court made an order rectifying the deeds in order to give effect to that intention.