Mediating tax disputes: HMRC’s ADR pilots

Over the course of the first half of 2011, HMRC have been exploring whether Alternative Dispute Resolution – specifically the involvement of a third party mediator – might be used in some tax disputes to facilitate agreement between HMRC and the taxpayer.

This has taken the form of ADR pilots aimed at clarifying the criteria for when mediation might be most appropriate for resolving tax disputes, to inform HMRC’s strategy and staff guidance for the use of ADR in civil tax disputes in future.

HMRC already have a well-established framework of principles and guidance within which they handles all tax disputes subject to civil law procedures, known as the Litigation and Settlement Strategy (LSS).

This reinforces the need for all tax disputes to be resolved consistently with the law, and it rules out any compromise settlement not based on an interpretation of the law which HMRC believe to be robust.

The LSS also encourages HMRC staff – where disputes arise – to seek non-confrontational solutions, and to find the most cost effective way of resolving the dispute and securing the tax due under the law at the least cost to HMRC and to taxpayers.

A key driver for HMRC’s ADR pilots has therefore been to explore how collaborative dispute resolution techniques involving a third party can support the cost-effective resolution of disputes within the framework of the LSS.

HMRC have undertaken two separate ADR pilots.

One is a small scale pilot – covering fewer than 20 cases involving large businesses or taxpayers with complex tax affairs – in which the relevant disputes have been subject to an ADR process which includes the involvement of a third-party accredited mediator (the ‘LB ADR pilot’).

The other is a larger pilot for disputes involving mainly Small and Medium-sized Enterprises – covering around 150 cases and involving an in-house HMRC trained facilitator to help the parties agree resolution (the ‘SME ADR pilot’).

This article summarises the results of the pilots up to May 2011, and the lessons learned so far.

Interim results: LB ADR pilots

By May 2011, 11 cases had been selected, out of a total of over 50 considered, for inclusion in the LB ADR pilot.

These included seven disputes relating to VAT, and four relating to various direct taxes.

Each dispute was brought into an ADR process governed by an ADR agreement setting out the steps and timetable, the individuals to be involved from each party, and the ground rules for the process.

The ground rules included a commitment to work collaboratively to resolve the dispute, including through the joint appointment of a mediator, should that prove necessary.

For the majority of the cases, rather than going straight to mediation, the ADR process has involved preliminary facilitated structured discussions to see if the parties can resolve the dispute without a mediator, or at least better prepare for mediation, by ensuring they fully understand their respective arguments and the points of agreement and disagreement.

The structured discussions in these cases have been facilitated by members of the parties’ own teams and have been conducted expressly on equal terms, recognising the dispute as a shared issue which the parties have a shared interest in resolving.

By May 2011, two cases had been resolved in a mediation, with a further two cases on the point of going to mediation.

Another case in the pilot had been resolved through the structured discussions, with a further one or two cases on the point of being resolved bilaterally.

The remaining four cases are at various stages in the facilitated structured discussion process.

Of the cases in which a third party accredited mediator has been (or will shortly be) appointed, one has involved facilitative mediation (where the mediator remains neutral throughout and tries to bring the parties together), one has involved evaluative mediation (where the mediator is a tax specialist and, while trying to bring the parties together, may also provide his/her view on the matter), and two involve non-binding expert determination (where a chosen expert reviews, considers and provides a view on a non-tax issue relevant to the tax dispute, such as a valuation, and the expectation is that the parties will settle in accordance with that view).

The cases in the LB ADR pilot have been resource intensive, but HMRC still estimate that considerable savings have been made compared with resolving the relevant disputes through litigation.

Interim results: SME ADR pilots

Over 150 cases had entered the SME ADR pilot by May 2011.

These were all cases otherwise headed for an internal HMRC review – ie, at an advanced stage of the disputes process – in which the offer of a mediation involving an internal HMRC facilitator (a ‘facilitation’) was offered as a means of resolving the dispute by agreement.

97% of those taxpayers offered such facilitations took up the offer, and 28 facilitations were completed by May 2011, resolving the dispute in whole or in part in 64% of cases, and taking on average 28 days.

The HMRC facilitators have been trained to listen, consider and to discuss the key issues in dispute with both parties and support them in reaching agreement as quickly as possible.

The facilitators have worked mainly through telephone contacts, but also on occasions through facilitated discussions, all conducted in open (three-way) session, rather than using private sessions with each party.

A key objective of the SME ADR pilot, as well as testing the benefit of using a ‘third-party’ mediator/facilitator in resolving disputes, is to get a better understanding of why disputes in this category reach an impasse, with a view to remedying upstream processes.

Feedback from the pilot is therefore informing the design of HMRC’s Single Compliance Process for SMEs and other relevant taxpayer groups.

When might an ADR process be appropriate for tax disputes?

The experience gained with the ADR pilots has suggested that there is a wide range of features which can make a tax dispute particularly suitable for an ADR process.

These include:

• uncertainty over the facts, or over which facts are relevant to the dispute;
• fact-specific cases where there is limited precedent value or where there is likely to be a range of possible outcomes which could be regarded as robust in law;
• a lack of clarity/ understanding of the parties’ respective technical analysis of the tax law in question;
• cases where positions have become entrenched based on early conclusions (or assumptions) about the facts, or on what appears to be an ‘all or nothing’ interpretation of tax law, where there may be scope to explore alternative realistic ways of looking at the facts, or alternative analyses of the law, either of which may unlock the impasse;
• cases where genuine attempts to work collaboratively to resolve the dispute have stalled; and
• two or more taxpayers involved or potentially affected by a specific dispute who might be prepared to take part in a confidential dispute resolution process.

Features which can make a tax dispute less suited for an ADR process include:

• where there has been little or no bilateral engagement between the parties to date, or where productive discussions between the parties are ongoing, or where alternative (accelerated) collaborative working processes are available which make ADR unnecessary or premature;
• where the taxpayer (or their agent) is unwilling or unable to commit to a cooperative and collaborative approach;
• a fundamental difference in legal interpretation between the parties where HMRC have a clear policy which it wishes to maintain and there is no obvious lack of clarity in relation to the facts or each other’s interpretation of the law; and
• an issue which affects a large number of taxpayers with significant amounts of tax revenue at stake.

What are the key benefits of mediation identified from HMRC’s ADR pilots?

The resolution mindset encouraged by facilitators or a mediator can help the parties to unblock an impasse:

Many of the cases in the ADR pilot involved long running disputes which were heading towards litigation.

Often the cases had reached an apparent impasse, with one or both side(s) seemingly entrenched in their positions, despite previous efforts at working collaboratively.

The resolution mindset facilitated by the ADR process unlocked the scope for mutually acceptable solutions to the dispute, such as by the parties working step by step through the development of a decision tree, through actively setting aside areas of disagreement which did not have to be addressed in order to resolve the dispute, and by working jointly towards a robust and agreed analysis of the facts and applicable tax law.

Solutions to difficult tax questions agreed through ADR can help to provide certainty as to how similar questions should be handled in future, as well as resolving the dispute for current and past periods.

Feedback from taxpayers and agents, as well as from HMRC staff, has confirmed that in-house facilitators/mediators acting objectively and even-handedly can bring these benefits as well as those who are formally ‘independent’.

ADR can provide a process for helping the parties clarify and agree what facts are relevant:

In one tax dispute, already more than ten years old, the parties had lost sight of the critical issues and neither party was able clearly to articulate the key questions which needed to be answered in order to resolve the dispute.

Going through a process of jointly identifying, articulating and agreeing what these key questions were helped refocus the parties on the important issues and also provided a framework for further discussions.

ADR can help the parties get a better understanding of what is important to each otherin the dispute:

For example, resolution of one dispute was facilitated by HMRC including formal confirmation of its position on various other tax claims which were not part of the main dispute, and agreeing to resolve matters by a certain date, both of which were particularly important to the taxpayer concerned.

In another case, it was recognised that HMRC’s labelling of a transaction as ‘unacceptable avoidance’ was preventing agreement, but by using different language HMRC were able to secure agreement to the same basis for settlement as it was previously seeking.

A mediator or facilitator can provide fresh impetus to discussions where relationships have deteriorated or where the relevant stakeholders are not fully engaged or involved:

Attempts to negotiate a settlement to one tax dispute had failed as a result – in part at least – of the company tax manager's generally confrontational approach to disputes with HMRC.

Through an ADR process leading potentially to a mediation, it was possible to develop a more objective and dispassionate dialogue to fully test the merits of the parties' respective interpretations of the law.

In another case, HMRC had previously corresponded with the taxpayer’s agent, who appeared focused on moving the case to litigation rather than necessarily on resolving the dispute.

The ADR process helped to facilitate discussions with the taxpayer directly.

The confidential nature of an ADR process has in another case facilitated three-way discussions between HMRC and both parties to a service contract which raises significant VAT issues for each party.

Involving third party facilitators or mediators can achieve time and cost savings for both parties:

For example, in one tax dispute at which agreement was reached during the formal mediation stage, the HMRC case owner estimated that resolving the dispute through the ADR process as opposed to taking the case to the First-tier Tribunal may have saved around 45–60 days work for various members of the HMRC team.

This is likely to have been matched by similar savings for the taxpayer.

Similarly, the costs of the LB ADR pilot mediation itself (which have been split 50:50 for all tax disputes) have turned out to be a fraction of the legal costs likely to have been incurred in litigation.

Similarly, costs savings have been achieved in the SME ADR pilot.

Even where parties are not able to reach an agreed resolution, an ADR process can help the parties prepare more effectively and efficiently for litigation:

For example, facilitated discussions in one case led to both parties concluding that the most efficient way of resolving the dispute would be through litigation.

But having come to this decision, the parties have continued to work together in order to make the litigation process as efficient as possible, by narrowing down the scope of the dispute to be litigated and agreeing the questions which need to be answered by the Courts.

Involving a third party mediator or facilitator alongside the existing team on each side can help transfer good dispute resolution skills and attitudes:

Although the pilots have shown the clear benefit of injecting a fresh perspective, they have also shown that bringing in a third party alongside, rather than replacing, the existing case team is a powerful way of transferring good dispute resolution skills and overcoming inevitable scepticism about the benefits of ADR.

As well as the benefits of using external accredited mediators and trained HMRC facilitators, the HMRC Dispute Resolution Unit has provided support to the case teams involved in the pilots and has drawn up practical guidance for HMRC staff involved in ADR processes in future.

Even simply considering a formal ADR process can provide the impetus for parties to start working more collaboratively and focus on potential routes to resolution:

In a number of cases where mediation was suggested by one of the parties, it appears that the process of discussing the case objectively and considering some kind of formal ADR process itself provided the impetus to the parties to look critically at the dispute, identifying ways of enhanced collaborative working which have led to the dispute being resolved by bilateral agreement.

More generally, those involved in pilot cases will have had an opportunity to learn more about why disputes become entrenched in the first place.

This should inform disputes handling procedures on both sides in future.

A useful role to play

HMRC’s pilots have demonstrated that mediation can have a useful role to play in the effective and efficient resolution of tax disputes.

Although mediation in tax disputes is likely to apply only in a relatively small minority of cases, just as in the commercial world, it will be a valuable tool for those seeking collaborative resolution of tax disputes, taking its place alongside the more traditional routes of bilateral discussion and agreement or the use of litigation where that is appropriate.

Sue Walton, Director, HMRC Central Policy