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Justice for taxpayer where tax charge "repugnant to common fairness"

29 April 2015

The Upper Tribunal of the Tax and Chancery Chamber has upheld a taxpayer's appeal against a £383,000 tax charge which potentially left him facing bankruptcy.

Mr Joost Lobler, a Dutch national, invested £960,000 in a Zurich life insurance policy in March 2006. His investment, in fact, consisted of 100 segments – each one a separate policy. Between 2006 and 2008 Mr Lobler withdrew 97.5% of his investment. He did this by electing to make partial withdrawals from all 100 policies, rather than encashing individual segments in full.

His mistake has been characterised in some media outlets as 'ticking the wrong box on the form', and that is a fairly accurate characterisation.

A quirk of the tax legislation (which has previously attracted criticism) provides that a partial surrender of a life insurance policy realises taxable income, nothwithstanding that no actual profit or gain is made on the policy. Thus, when Mr Lobler made his partial surrenders from all of his 100 polices, he triggered a very substantial tax liability.

The Upper Tribunal noted that when making his withdrawal Mr Lobler had ticked option 'C' on the surrender form he was provided with, resulting in a partial surrender of all policies. Option 'D', which Mr Lobler could just have easily and legitimately have selected, would have resulted in full surrender of individual policies and had he done so his tax liability would have been very significantly lower.

The tax charge that was triggered represented an effective tax rate of 779 per cent on actual income generated by the Zurich policies.

The First-tier Tribunal of the Tax Chamber had dismissed Mr Lobler's appeal with "heavy hearts" and openly acknowledged that its decision was "outrageously unfair" and "repugnant to common fairness".

The Upper Tribunal rejected grounds of appeal based on Human Rights and Public Law grounds, but found in favour of the Appellant on the ground of unilateral mistake.

Drawing on principles established in Pitt v. Holt the Upper Tribunal found that "a mistake as to the tax consequences of a transaction may, in an appropriate case, be sufficiently serious to warrant rescission and thus rectification'. Essentially, the Upper Tribunal found that Mr Lobler, who did not draw on the benefit of any legal or other advice in making his withdrawals and was held not to have acted carelessly, would never have willingly contracted to pay an amount of tax that would lead to his own bankruptcy. To make a successful challenge under Pitt v. Holt it had to be shown that the error went to the fundamental or root element of the transaction. The Upper Tribunal found that this was the case here and that "the effect of the withdrawal was entirely different from that which Mr Lobler believed it to be".

In giving Judgment, Mrs Justice Proudman DBE noted that the relevant provisions of the Income Tax (Trading and Other Income) Act 2005, which the tax charge had been triggered under, "is not at all intuitive and no reasonable man would have expected the outcome".

It remains to be seen whether the Chartered Institute of Taxation, which has been lobbying for changes to legislation in this area (and was permitted to make submissions to the Upper Tribunal in this case), will be successful in initiating legislative change. In the meantime, this judgment may well prove very significant indeed.