Analysis
John Selwyn Herbert (Mr Herbert), a widower with three children, owned and lived in the freehold house, 12 Hammersmith Terrace, London (the house). In 2001, Mr Herbert obtained inheritance tax advice from Stevens & Bolton to implement what was described as the ‘home loan scheme’ and he asked the second appellant, Mr Shelford, who was a solicitor and partner in Edwin Coe, to act as a trustee of the Herbert Life Interest Settlement (the settlement).
The settlement, which was dated 21 March 2002, was established by Mr Herbert with a nominal sum of £10 upon trust for himself during his life and with power to pay or apply the capital to or for his benefit and, subject thereto, upon trust for such of his children as were then living in equal shares with further trusts and powers engrafted thereon. By a sale agreement dated 22 March 2002 (the sale agreement), Mr Herbert agreed to sell the house to himself and Mr Shelford as trustees of the settlement for £1.4m. By a loan agreement dated 22 March 2002 (the loan agreement) Mr Herbert agreed with himself and Mr Shelford as trustees of the settlement to leave the sale price outstanding by way of an interest-free loan repayable by written demand given at any time after his death. By a deed of assignment dated 16 April 2002 (the deed of assignment) Mr Herbert assigned his interest in the debt created by the loan agreement to his children in equal shares absolutely.
Mr Herbert continued to reside, rent-free, at the house until his death and paid pre-owned asset tax from 2005 onwards, aggregating in total to £196,013. The house was worth £2.85m when Mr Herbert died on 27 September 2013. The house was subsequently sold to third parties for £3.9m on 30 June 2016. The trustees of the settlement paid the amounts due under the loan agreement when written demands were made in June and July 2018.
HMRC issued determinations to each of the executors of Mr Herbert and to Mr Shelford as trustee of the settlement that, having regard to the purpose and effect of the arrangements made, the house was property subject to a reservation of benefit on the death of Mr Herbert and therefore it should be treated for the purposes of inheritance tax as property to which he was beneficially entitled immediately before his death. The tax due was £560,000. The appellants appealed on 21 September 2016. The determinations were upheld on review and the appeal was notified to the tribunal on 6 December 2016.
Held (dismissing the appeal):
The trustees’ obligation to pay Mr Herbert the sale price of £1.4m under the sale agreement could not be set off against Mr Herbert’s obligation to lend the trustees the £1.4m under the loan agreement, nor were the circumstances such in which the obligation to pay the deposit under the sale agreement could be said to have been released and discharged by the assumption by the trustees of the obligations under the loan agreement. As Mr Herbert did not have £1.4m in cash to lend to the trustees, and the trustees did not have £1.4m in cash to pay the deposit, it was impossible for the two agreements to be severed and given separate effect; consequently the sale agreement and the loan agreement had to be read together as a single agreement.
Furthermore, since neither Mr Herbert nor Mr Shelford ever intended that the terms of the sale agreement and the loan agreement be honoured, the two agreements had been mislabelled. There was an air of unreality about them read as separate agreements. The true effect of the sale agreement and the loan agreement, when read together, was that Mr Herbert had agreed to sell the house to the trustees of the settlement with completion to occur (and the consideration to be paid) on notice following his death. The true effect of the subsequent deed of assignment was that Mr Herbert had gifted to his three children the right of his estate to pay the consideration on completion after his death. In the light of this analysis, the sale agreement was void because it did not incorporate all the terms of the contract for the sale of the house as required by s2 of the Law of Property (Miscellaneous Provisions) Act 1989. In consequence, the deed of assignment had nothing on which to ‘bite’ as there were no sale proceeds or loan benefit which could be assigned. There had been a fundamental common mistake and in consequence the deed of assignment was also void. It followed that the house formed part of Mr Herbert’s estate at his death.
Alternatively, if the sale agreement was not void, the house would have formed part of Mr Herbert’s estate, albeit subject to the sale agreement in favour of the trustees of the settlement, and his estate would have had no entitlement to the sale proceeds as this right had been gifted to the children by the deed of assignment. The trustees of the settlement did not acquire an unfettered equitable interest in the house under the sale agreement; the equitable interest in the house only passed to the trustees of the settlement when the consideration was paid following the death of Mr Herbert. In fact, the sale of the house had been at a significant undervalue because Mr Herbert had agreed to sell it for £1.4m payable on his death whereas the value of the debt under the loan agreement according to unchallenged expert evidence was only £532,500 (discounted to take account of the fact that it was interest fee, secured, illiquid and only repayable on the death of Mr Herbert). Section 163 of the Inheritance Tax Act 1984, which was not restricted in its application to options, applied to the sale agreement because, by agreeing to sell the house to the trustees of the settlement with completion (and payment of the consideration) to be deferred until after his death, Mr Herbert had excluded or restricted his ability to dispose of the house. In consequence, the value of the house as at the date of death fell to be included in the value of Mr Herbert’s estate. This included the settled property to which Mr Herbert had a qualifying interest in possession as he was treated for inheritance tax purposes as being beneficially entitled to the property in which his life interest subsisted.
As at the date of death, the trustees of the settlement had a contractual obligation to pay £1.4m to Mr Herbert’s children as consideration for a property that was then worth £2.85m. It followed that the value of the settled estate was the £10 originally settled by Mr Herbert (together with interest) plus £1.45m (ie £2.85m less £1.4m) and this would have to be included in the tax computation.
Obiter dicta:
This conclusion would lead to an element of double taxation as the house was included not only in the valuation of Mr Herbert’s estate, but also the settled estate at its market value on death, albeit with a deduction for the purchase consideration payable to the children in the case of the settlement. It served as a warning that the implementation of tax avoidance schemes can sometimes have the consequence of the participants paying more tax than if they had done nothing.
JUDGMENT JUDGE ALEKSANDER: Introduction [1] These appeals are against the determinations by HMRC issued on 22 August 2016 under s222 Inheritance Tax Act 1984 (‘IHTA’). The inheritance tax (‘IHT’) in dispute is £560,000. [2] The determinations were issued, all in the same terms, to each of the four executors of John Selwyn Herbert (‘Mr Herbert’), …Continue reading "Shelford & anr v HMRC [2020] WTLR 657"