Q&A: Lessons from Lobler on rectification and mistake

What is the significance of the decision in Lobler?

Lobler v HMRC [2015] UKUT 0152 explains how the contract law rules of rectification and rescission for mistake apply in the tax context.

In Pitt v Holt [2013] UKSC 26, the Supreme Court had, as well as delineating the boundaries of the rule in Hastings-Bass [1974] 2 All ER 193), provided guidance on the contract law rules on rectification and rescission for mistake in a tax context. Lobler is a practical illustration of how the courts apply the law. As will be seen, the Upper Tribunal appears to have applied the law in a slightly different way from the Supreme Court. However, the positive outcome for the taxpayer would in all likelihood have been the same if the Upper Tribunal’s reasoning had been in complete accord with that of the Supreme Court.

The Lobler litigation was on the rules on partial surrenders of insurance policies in ITTOIA 2005 s 507. This legislation had been considered by the courts before in Mayes v HMRC [2011] EWCA Civ 407, and it can give rise to artificial results.

What were the facts?

Mr Lobler had invested $1.4m in life policies which were issued to him by Zurich Life. He effected two withdrawals from the policies of $746,485 and $690,171 respectively. The withdrawal documentation gave Mr Lobler a choice as to whether to withdraw the funds by the full surrender of certain policies, or whether to effect the withdrawal through the partial surrender of a series of policies. Mr Lobler chose the latter alternative. Unfortunately, the rules on partial surrenders meant that he was subject to income tax on the proceeds of the partial surrenders paid out to him, even though his economic gains were small. The tax charge placed Mr Lobler at risk of personal bankruptcy. The matter was taken to the First-tier Tribunal and with ‘heavy hearts’ they dismissed Mr Lobler’s appeal.

What did the Upper Tribunal decide?

The Upper Tribunal reviewed the law on rectification of legal documents and the law on mistake, applying its interpretation of the judgment in Pitt v Holt.

The Upper Tribunal held:

‘It is clear from Pitt v Holt that a mistake as to the tax consequences of a transaction may, in an appropriate case, be sufficient to warrant rescission and thus rectification.’

The Supreme Court in Pitt v Holt had reformulated the law on mistake. Lord Walker held:

‘I would provisionally conclude that the true requirement is simply for there to be a causative mistake of sufficient gravity; and, as additional guidance to judges in finding and evaluating the facts of any particular case, that the test will normally be satisfied only when there is a mistake either as to the legal character or nature of a transaction, or as to some matter of fact or law which is basic to the transaction.’

Therefore, by allowing a mistake of law to be taken into account, the Supreme Court conceptually allowed a mistake as to tax law to constitute the grounds for the rescission of a contract for mistake.

However, the Upper Tribunal held that rescission for mistake was unavailable on these facts: ‘because the party receiving the benefit of the mistake is not Zurich but a third party to the policy contract, HMRC’.

The Upper Tribunal went on to hold that rectification of the contract was available as a remedy, with the consequence that Mr Lobler should be treated as if he had made full surrenders of the life policies for tax purposes.

Was the Upper Tribunal correct in holding that mistake as a remedy was unavailable on these facts?

The Upper Tribunal’s judgment that rescission for mistake was unavailable as a remedy because a third party, (i.e. HMRC) benefited from the mistake sits uneasily with the Supreme Court’s judgment in Pitt v Holt.

Mrs Pitt was the receiver of her disabled husband’s property. After having received professional advice, Mrs Pitt settled funds on a trust for her disabled husband. It was believed that the settlement of funds would not crystallise inheritance tax charges. Unfortunately, inheritance tax costs arose. The Supreme Court held that rescission for mistake was available on these facts. It had no regard to the fact that a third party, namely HMRC, benefited from the mistake; and the judgment made no mention of a third party benefit being a barrier to a mistake claim.

Was the Upper Tribunal correct in holding that rectification as a remedy was available on these facts?

In Pitt v Holt, the Supreme Court did not restate the rules on rectification. The Supreme Court maintained the traditional position:

‘Rectification is a closely guarded remedy, strictly limited to some clearly established dispute between the words of a legal document, and the intention of the parties to it. It is not concerned with consequences.’

When Mr Lobler withdrew funds from his policies, he consciously knew he was making partial surrenders. The unforeseen tax charges were an error as to the tax consequences of that act. Therefore, the Upper Tribunal’s judgment on rectification sits uneasily with the legal test for the availability of rectification, as set out by the Supreme Court, which ignores consequences.

In summary, the Upper Tribunal gave what was morally the correct judgment in Lobler. However, taking the viewpoint of a legal purist, it is arguably the case that rescission for mistake is a more robust foundation for the judgment than the rules on rectification of documents.

Note: As previously reported in Tax Journal, several cases involving taxpayers in similar circumstances had been stayed pending the outcome of this appeal. The CIOT intends to make formal submissions to HMRC and the Treasury to obtain a change in the law.

Adapted from an interview by Kate Beaumont for LexisNexis UK Legal News Analysis and Lexis®PSL Tax