Solicitors' PI: Failure to Warn and Tax Avoidance Schemes

The High Court recently held in Barker v Baxendale Walker Solicitors that, whilst a firm of specialist tax solicitors had not given negligent advice regarding a tax avoidance scheme, it had breached its duty by failing to give a general warning that the scheme might be challenged by HMRC. In this case, however, the breach was not causative.

It is established law that the standard of care is that of the reasonably competent practitioner in the relevant sector of the profession who apples proper skill and care (Matrix Securities Ltd v Theodore Goddard (a firm) & another).

The judge here provided some helpful guidance on such standard of care, non-negligent errors and duty to warn in the context of specialist advice and statutory interpretation.

Background

The solicitors gave the Claimant tax planning advice on the disposal of shares. The facts are complex but essentially the claim concerned the solicitors’ advice that an Employee Benefit Trust would comply with s.28 of the Inheritance Tax Act. The advice was that the EBT would comply if the Claimant’s family could only receive distributions from the trust after his death. Compliance would have meant that the Claimant’s key objective - to avoid a capital gains tax liability altogether – would have been met.

HMRC later adopted the position that the EBT was ineffective on the basis that s.28 of the Act required the Claimant’s family to be permanently excluded as beneficiaries and not just until after his death.

The Claimant alleged that the solicitors’ interpretation of the Act was negligent. Alternatively, that the solicitors should have warned of a significant risk that their interpretation was incorrect. The Claimant said that, but for solicitors’ negligence, he would have used an alternative scheme.

Decision

The Court held that a question of statutory construction, unless it is very simple or obvious, is in reality a question of what a court will hold the provision means i.e. it is a question of judgment. The test here was whether a competent tax QC at the time, with particular expertise in tax avoidance schemes, could have advised as the defendant solicitors did. The applicable standard was that of a tax QC, as the solicitors were content to advise without counsel’s input.

Notwithstanding the high standard, the Court found that the solicitors’ interpretation of the Act was not negligent. It was relevant that several experienced tax specialists had independently interpreted the legislation in the same way.

The Court found that the solicitors had, however, breached their duty in failing to give a general warning to the Claimant. The judge commented that whether a solicitor’s duty of care requires a warning of an alternative interpretation depends on the circumstances. Of particular significance in this regard is whether the solicitor can be reasonably confident that their interpretation is correct or whether the risk of an alternative interpretation is clear. The judge found that HMRC’s interpretation of the Act was neither obvious nor likely and so the solicitors were not negligent by virtue of not having given a specific warning. Aside from that, however, the Court held that the solicitors should have given a general “health warning” of the possibility of a tax avoidance scheme being challenged by HMRC.

It was relevant that the solicitors gave extremely confident advice on the EBT option, subject to no real qualification at all. The solicitors did point to risks, but they did so after the trust had been set up. The Claimant could have refused to transfer the shares into the EBT at that stage, but the solicitors did not discharge their duty to warn (in the general terms discussed above) at the time of their original advice. The court held that the duty is greater before a client embarks on a particular course of action.

Despite the limited breach of duty, the Court found that a “general health warning” would not have deterred the Claimant from entering the scheme. The Claimant was found to be a man of considerable intelligence and entrepreneurial skill who, on the evidence, knew it was an aggressive tax planning scheme that would always be subject to different opinions. The Claimant had in fact been given a “general health warning” by other advisors about the alternative scheme he said he would have chosen “but for” the solicitors’ advice.

Causation was particularly key in this case. The Court found that, had the Claimant been warned of a significant risk that HMRC would adopt the alternative interpretation of the Act, the Claimant would not have proceeded. The finding that the solicitors did not owe a duty to give that specific warning was, therefore, pivotal.

Comment

The case highlights the importance of warning clients, where appropriate, of both general risks (even where a firm is confident its advice or interpretation is correct) and specific risks (for example, where a solicitor’s judgment is more finely balanced). Firms will be exposed both where appropriate warnings are not given at all and where they are only given after a client has embarked upon a particular course of action. As with all important advice, risk warnings to clients should be recorded in writing.


Further reading: Barker v Baxendale Walker Solicitors (a firm) [2016] EWHC 644 (Ch)