Rediscovering ADR

23 June 2021. Published by Adam Craggs, Partner

Alternative Dispute Resolution (ADR), in the form of mediation, remains an important part of the tax dispute resolution process. In light of the backlog of cases caused by Covid-19, and the practice statement issued by the Tribunal last year, we expect that taxpayers and HMRC will begin to re-examine and embrace ADR which can be an effective method of resolving disputes with HMRC.

This blog is based on an article first published in Taxation on 25 May 2021. A link to the article can be found here 

Recent downturn in the use of ADR

Until relatively recently, HMRC imposed strict conditions on the timing of when an application for ADR could be made, refusing to consider any application which was made after it had formally set out its position in its 'statement of case'. This gave taxpayers a limited window in which to apply for ADR after HMRC's enquiries had concluded. This unilaterally imposed restriction on the timing of ADR applications was disappointing, principally because there was no statutory basis for it and it seemed counter-intuitive to treat the provision of HMRC's statement of case as a barrier to ADR, when delivery of that document provides both parties with an opportunity to reappraise the strength and weaknesses of their respective positions and consider whether there is any scope to explore settlement through ADR. This restrictive approach may have been a factor in the decline in the use of ADR in recent years. The amount of tax that HMRC has raised as a consequence of resolving tax disputes through ADR dropped by 40% in the last year, from £44.5m in 2019 to £26.6m in 2020. Similarly, in 2019/20, there were 1,066 ADR applications made through HMRC's online system, a fall of 6.8% on the previous year.1

First-tier Tribunal's ADR practice direction

On 15 June 2020, the First-tier Tribunal (FTT) published a practice statement on the use of ADR in tax disputes once an appeal has been made to the FTT. Under Rule 3(1) of the Tribunal Procedure (First-tier) (Tax Chamber) Rules 2009 (SI 2009/273), the FTT should, where appropriate, make the parties aware of, and facilitate the use of, ADR. In pursuance of that obligation, the practice statement provides that all parties should consider the use of ADR where appropriate, at any stage in the proceedings, including after HMRC has provided its statement of case.  

Following publication of this practice statement, HMRC updated its guidance on ADR. It now accepts that ADR can be used at any stage in the litigation process, even after it has filed its statement of case. Given the high number of cases the FTT has to determine (the number of appeals disposed of in 2019/20 was 7,533), encouraging use of ADR is to be welcomed. In addition to issuing its practice statement, we would encourage the FTT to consider issuing a standard letter to the parties once an appeal is registered with it, bringing to the parties' attention the availability of ADR and urging them to consider whether the case is one suitable for resolution by ADR. 

Following publication of the FTT's practice statement and possibly as a consequence of the inevitable delay in listing appeals before the FTT due to the difficulties created by the Covid-19 pandemic, HMRC has in recent months been more amenable to resolving disputes by way of ADR. We have found that, although Covid-19 restrictions have meant that ADR meetings have had to be held by video rather than in person (which given the nature of ADR is not ideal), the ADR process has adapted well to virtual mediations and notwithstanding the lack of in-person interaction we have, in recent months, been involved in a number of successful mediations.  

Advantages of ADR

There are a number of advantages of ADR, the main ones being:

Speed 

An enquiry by HMRC often lasts many months or even years, and may then be followed by litigation before the tax tribunals and the higher courts, which will normally take several more years to resolve. Once the parties have agreed to mediate, the mediation can be set up relatively quickly and, if it results in a settlement, the matter can be disposed of much earlier than might otherwise be the case. 

Confidentiality  

HMRC is required to maintain taxpayer confidentiality throughout the enquiry process. However, once a matter proceeds to a hearing before the FTT, the dispute is no longer confidential. The hearing itself is open to the public. The FTT's decision (and the decisions of the Upper Tribunal and any higher courts, should the matter proceed on appeal) will be published and will contain findings of fact (including possible reference to the amounts of tax at stake) and summaries of the evidence presented. While it is possible, in some instances, to apply for a direction from the FTT that the hearing be held in private or that the decision be anonymised, the FTT will only make such a direction in exceptional circumstances. In contrast, mediation is confidential; both the mediation itself and the terms of any agreement reached between the parties should not be made public without express permission from the parties. This can be an important consideration for 'high profile' taxpayers.

Costs  

Although the parties may need to pay the cost of hiring a venue for the mediation and any legal fees for representation at the mediation, the cost of mediation is likely to be significantly less than the costs associated with litigation.

Control 

The parties retain a much greater degree of choice and control in the mediation process compared with litigation. The FTT is likely to issue various case management directions during the litigation process that the parties are obliged to comply with. In ADR, the parties can set the parameters of discussions themselves and agree when the mediation will take place. Similarly, while the parties will make their legal submissions to the FTT in support of their respective cases, they are unable to prevent the FTT from supporting its decision on a legal basis that neither party advocated or supports. That risk is obviated if ADR is pursued. 

Litigation remains an option  

The parties retain the right to litigate if the mediation does not lead to settlement. Even in instances where mediation fails, it is usually the case that the issues between the parties will have become more focused and it is likely that the parties will better understand each other's respective positions as a consequence of the ADR process.

Top tips for a successful ADR

Opening statements  

In advance of the mediation, the parties will ordinarily exchange their opening statements. These need not be lengthy documents, but they can assist in framing the parties' respective cases and can serve as a useful indicator of how the issues should be approached (and in what order). If a dispute is particularly complex, a more detailed opening statement may be appropriate. These statements are normally exchanged seven days in advance of the mediation day. If a more detailed opening statement is necessary, it may assist the mediation process if the parties' opening statements are exchanged earlier than seven days before mediation. Parties may consider it appropriate to serve supplementary or response statements, in order to further narrow down the issues between them. Although ADR is conducted outside of the formal litigation process, and opening statements should not be drafted in the same way as formal pleadings, taxpayers should not underestimate the usefulness of having their positions set out fully in writing before the mediation day. This can help the parties to focus on the areas of real dispute, which can in turn increase the likelihood of settlement.

Identify your starting position and know your 'bottom line' 

ADR often involves compromises on both sides. It will ultimately depend on the individual circumstances of each case as to what a party is prepared to accept in order to bring a dispute to a conclusion. Some issues are binary, but others lend themselves to compromise. Where a party enters into mediation willing to compromise, or concede part of their case, this can set the tone for meaningful mediation, with the other party being encouraged to respond in kind, which is likely to enhance the chances of a successful settlement agreement being reached. 

Understand HMRC's Litigation and Settlement Strategy 

Although tax mediation is essentially no different to any other mediation, one key distinction arises from HMRC's status as a public body. HMRC does have a degree of discretion as to how to fulfil its obligation to collect revenues but, in contrast with commercial organisations, it also has duties to the wider body of taxpayers and this can restrict its freedom to enter into a negotiated settlement. One such restriction is created by HMRC's Litigation and Settlement Strategy (LSS), which was first published in 2007 and which is the framework within which HMRC will seek to resolve tax disputes through civil procedures.

Any decision by HMRC to settle a case during a mediation process will be governed by the terms of the LSS. One of the fundamental principles of the LSS is that the full amount of tax assessed is to be sought wherever HMRC believes that it is likely to succeed in litigation. That said, ADR can, in practice, afford HMRC an opportunity to adopt a more flexible approach in reaching resolution to a tax dispute. HMRC accepts that there may be a range of outcomes in some cases and is permitted to settle on an alternative principled basis provided that this would be one of the ‘likely outcomes’ in litigation. 

Know who you are negotiating with 

It is important that the key decision makers are in attendance at a mediation meeting, or are at least easily contactable on the day of the meeting. It can be very frustrating for taxpayers to be under the impression that they have successfully negotiated a settlement with HMRC, only later to be informed that further internal HMRC approval is required, which is ultimately not forthcoming. In order to avoid this potential pitfall, taxpayers should request a list of HMRC attendees in advance of the mediation meeting, together with their roles, and confirmation that they have authority to bind HMRC in the context of the mediation. 

Consider the role that penalties might play in reaching agreement 

Where agreement regarding the underlying substantive dispute is close, consider whether agreeing to pay a limited penalty might help secure settlement. Ultimately, for many clients, it is the overall amount they have to pay HMRC which matters rather than how that sum is broken down. If the imposition of a penalty would lead to settlement of a long-running dispute, many clients will be prepared to agree such a settlement provided the global settlement sum is acceptable to them. Consideration should also be given to whether HMRC would be prepared to 'suspend' any penalty that is agreed as part of any settlement. 

It's not all without prejudice 

Whilst discussions in ADR will be conducted on a 'without prejudice' basis (ie those discussions cannot later be admitted in evidence before the FTT without the consent of both parties concerned, should settlement negotiations subsequently break down and the dispute come before the FTT or courts) and the HMRC mediator will be independent of the HMRC case officers, if the mediator does become aware of any new information that may have a bearing on the correct amount of tax due from the taxpayer, that information can be passed on to the appropriate personnel within HMRC. This important exception needs to be appreciated by those seeking to resolve a tax dispute through HMRC's ADR procedure. 

The exit agreement  

At the end of a successful mediation, the parties will usually be asked to enter into an exit agreement which reflects the terms of any agreement reached. This serves as an important record of what has been agreed, together with any ongoing obligations on the parties. One usual obligation on HMRC will be to withdraw or amend an assessment within a certain period of time, and or to agree to the position with regard to any penalties which may have been issued. This document may also be important in relation to the position regarding future tax years. It is therefore important that the exit agreement is drawn up as soon as possible whilst memories are fresh, and comprehensively records everything that was agreed between the parties. A well drafted exit agreement will minimise the risk of a dispute developing between the parties at a later date as to what precisely they agreed at the mediation meeting.  

Leave your emotions at the door 

HMRC enquiries can often be long-running and draining, both from a financial and emotional perspective, for clients. Ultimately, parties engage in ADR in order to reach agreement and conclude their dispute. ADR can be a cathartic experience for clients, giving them an opportunity to articulate their position to HMRC and, hopefully, draw a line under their dispute. Clinging on to issues that have caused irritation or consternation during the course of a long-running enquiry is likely to be counterproductive. Although not always easy, the parties should make every effort to engage in the mediation process dispassionately and without recriminations. Such an approach will enhance the prospects of the mediation being successful.

Some final thoughts

ADR can be a suitable mechanism for resolving a wide range of disputes across all taxes. In particular, it can be useful in long-running disputes where the parties' positions have become firmly entrenched and capitulation by one party, or litigation, appears to be the only option. Given the backlog in cases caused by Covid-19, we anticipate that HMRC will increasingly encourage the use of ADR. 

Although ADR can be an effective alternative to litigation, it is necessary to consider carefully whether ADR is suitable in the particular circumstances of your own case before submitting a request to HMRC. That said, given the non-binding nature of mediation and the other advantages of ADR discussed above, there is little downside in attempting to resolve a tax dispute by means of mediation.

Footnotes

1. HMRC Annual Report and Accounts 2019 to 2020

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