By Paul Clarke, Tax Resolution Director at Brown Butler
Receiving news of a tax investigation from HM Revenue & Customs (HMRC) is never a welcome experience for any individual taxpayer or business.
It is an event that few people hopefully undergo more than once in their lives but this in many ways can create greater uncertainties regarding an investigation for those that suddenly find themselves subject to one.
Taxpayers are often well aware of the costs of tax investigations and the length of the tribunal process they may face.
For those businesses or individuals without sufficient tax investigation protection or effective representation, it can be a very expensive and stressful time.
Many taxpayers assume that the only method for resolving their tax enquiry is by paying their penalties or charge or challenging a decision via a tribunal when instead Alternative Dispute Resolution (ADR) offers a cost-effective and quicker solution in many cases.
Why is ADR underutilised?
It was recently reported by City law firm RPC that HMRC’s yield from ADR had dropped 40 per cent to £27 million in the last year and that the number of applications for mediation fell by four per cent from 1,114 to 1,066.
RPC stated in its report that ADR has fallen, in part, because HMRC imposed strict criteria on when an application for ADR could be made.
While this is somewhat true, there remains a more immediate reason why ADR isn’t employed more regularly – many taxpayers, firms and even some HMRC inspectors aren’t fully aware or confident enough of the process to utilise this useful service.
From an anecdotal standpoint, we are regularly surprised at how little is known about mediation via ADR, which simply involves HMRC mediators working collaboratively with taxpayers and their advisers and with HMRC themselves to facilitate a settlement of the taxpayer’s dispute.
We are often approached by smaller accountancy firms seeking advice, whose clients are facing an enquiry.
They assume like the taxpayer that the only method of challenging HMRC is to seek a resolution via a tribunal or they do not feel sufficiently educated on ADR to make an application themselves.
Many are surprised that ADR is a suitable route for their case and that it is not only cheaper but often a faster and less onerous process. Even in the age of COVID-19 ADR meetings have been going on remotely with only minor changes and delays.
Similarly, we have come across some HMRC inspectors that were unsure whether ADR was suitable based on the criteria of the case, only to learn after we submitted an application to HMRC’s ADR service that the matter can go to mediation.
ADR isn’t suitable for every tax enquiry and HMRC often does not even entertain the idea of using it in tax evasion and avoidance cases that are clear cut. They will not normally accept an application for ADR where, for example, tax avoidance schemes have been used.
However, there remain many other instances where an application for ADR will be accepted, particularly where the issues involve a misunderstanding of the facts, or positions have become entrenched, as is often the case.
The answer to the above question, therefore, is that ADR surprisingly still remains little known about, despite HMRC saying in 2013 that it had become ‘part of their normal business’.
Assessing and proving taxpayer behaviour
Where ADR can particularly be useful is in providing clarity on the facts and to explain the behaviour of the taxpayer, particularly in a dispute over penalties that HMRC are seeking to levy for alleged careless or deliberate behaviour.
When a taxpayer is initially contacted about an enquiry, they may not often appreciate the importance of the accusations put against them.
They often do not understand the basic differences between ‘careless’, ‘deliberate’ and ‘deliberate and concealed’, which were introduced under the behaviour-based penalties regime in the Finance Act 2007.
Under this system, when assessing carelessness versus deliberate behaviour, HMRC will generally take into account:
- How significant the error is within the context of the taxpayer’s liability for the year;
- The taxpayer’s abilities and experience; and
- Supporting evidence or mitigations, such as whether that person has health issues or if there are other legitimate reasons for that person making a mistake, such as inaccurate professional advice from a third party.
It is little known that it is HMRC’s responsibility in such cases to prove, that on the balance of probabilities, the taxpayer has behaved in a way that it has prescribed.
To some degree, these assessments are subjective and HMRC does not always have a full appraisal of the situation when making these determinations, which can effectively create grey areas within an enquiry that can become subject to review.
This situation opens the door to taxpayers to challenge these decisions and ADR is an excellent method of doing so, as it not only puts the ball back in HMRC’s court to actually prove the matter but enables the taxpayer to present verbal evidence to demonstrate that their actions were at worst ‘careless’.
What next for ADR?
Our view of ADR is that it is an effective and cost-efficient alternative to tribunals, which not only saves clients time and money but also reduces the burden on the already stretched tax tribunal system.
HMRC should suggest ADR in more cases to a greater number of firms and perhaps provide more information and education on the process to taxpayers when they are informed of an investigation so that they can seek a resolution via mediation.
The lack of ADR cases has so far demonstrated a missed opportunity by HMRC. It is, though, also the responsibility of professional advisers to be more aware of the significant opportunities that ADR presents to resolve many disputes with HMRC in a timely and cost-effective manner.