Common law mistake as to tax consequences

The decision of the FTT in Mahmood v HMRC [2024] UKFTT 114 is a useful reminder that it is not possible simply to rescind arrangements on the basis that they had an unexpected tax effect. A mistake as to the tax consequences of a transaction is not sufficient to entitle the parties to treat the transaction as never having had effect.

Background

The case concerned the transfer by M of various business properties to a company, RKP, wholly owned by his wife. The properties were transferred at cost (£300,000), that amount left outstanding as a loan from M to RKP. M did not include the disposal of the properties on his tax return and HMRC enquired into the return and issued a closure notice assessing M to tax on the disposal of the properties at market value.

M (and RKP of whom M was a director) were under the mistaken belief that no tax would arise on the transaction. That was either on the basis that the transfer fell within the exemption for transfers between spouses (TCGA 1992 s.58) or on the basis that the properties were transferred at cost. When they discovered that the transfer was required to brought into account at the market value of the properties (under TCGA 1992 s.18 as a transaction between connected parties), they sought to rescind the transactions.

M accepted that a transfer of the properties would have taken place at market value, but claimed that the effect of rescinding the contracts was that the transfers were treated as never having happened so that no tax liability arose.

FTT decision

The FTT noted that M was relying on the common law doctrine of mistake under which a transaction may be void if the parties enter into it on the basis of a mistaken belief (and there was no application to the court under the equitable doctrine of mistake to set aside the transaction).

The FTT further noted that, based on the House of Lords decision in Bell v Lever Brothers, it was clear that for a mistake to render an arrangement void, the mistake must relate to the nature of the subject matter of the transaction or the way in which the transaction was to be performed. It was clear that the mistake could not simply relate to the consequence resulting from the transaction, not forming part of the transaction.

The mistake in this case was clearly one simply as to the consequences of the transaction ie that the transaction would not give rise to a capital gain. The liability to CGT had not impact on the subject matter or the terms of the bargain made nor the way in which it was performed. Therefore, the nature of the mistake in this case was not one which, under common law, is capable of allowing the parties to rescind the transaction.

The FTT also noted that whilst the parties may voluntarily rescind a transaction for any reason (not just mistake), that is only where it has only been partly performed. That was not the case here. In addition, the FTT observed that rescission in such a case merely puts an end to any further obligations under the contract and does not have the effect that any parts of the transaction that have been carried out are treated as no longer having had effect.

As a result, the FTT held that the purported rescission of the contract between M and RKP in this case had no effect and that CGT was due on the transaction based on the market value of the properties transferred.

Comment

The decision is a useful reminder of the very limited circumstances that taxpayers may revisit a transaction where there has been a mistake as to the tax consequences of carrying it out. Whilst the parties might agree to reverse that transaction, it will not have the effect of treating the transactions as never having had effect.

And whilst it is clear from the Supreme Court judgment in Pitt v Holt and Re Futter [2013 UKSC 26]  that the equitable doctrine of mistake may entitle a court to set aside a gratuitous transaction where there has been a mistake as to the tax implications of a transaction, it is unlikely to use that discretionary power where the parties have simply mis-predicted the tax consequences.