In an article first published in the 24 February edition of Tax Journal, Anastasia Nourescu and David Pickstone consider the pitfalls of HMRC’s newly published ADR guidance and how taxpayers and advisers should approach ADR going forward.

On 1 February 2023, HMRC published its first Alternative Dispute Resolution (“ADR”) guidance as part of its internal manual. At first glance, this may appear to be a step in the right direction, as it suggests HMRC is embracing ADR more than it has historically. However, a closer look shows that HMRC has taken this as an opportunity to impose one-sided requirements that make the process overly restrictive.

The principles of ADR

ADR in tax disputes normally refers to mediation rather than any more structured forms of ADR, such as arbitration. Indeed, Rule 3(2) of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009 (“the Tribunal Procedure Rules”) specifies that arbitration under Part I of the Arbitration Act 1996 does not apply to Tribunal proceedings.

The Civil Mediation Council (“CMC”) website lists five features of mediation:

• Mediation is a confidential process. The CMC states that “whatever is said and done, whatever unsuccessful offers are made to settle, none of it can be shared outside the mediation group unless agreed” and “cannot be repeated in court”.
• Mediation is a voluntary process: although it is directed and facilitated by a mediator, the parties must agree to take part, and they control the outcome.
• Mediation gives the parties the flexibility to enter into negotiations in an attempt to reach agreement outside litigation.
• Mediation can result in a binding settlement.
• Mediation offers access to justice as it allows the parties to settle the dispute in a confidential manner, and it is quicker and cheaper than litigation.

The mediation process takes place on a ‘without prejudice’ basis, which means no evidence of negotiations can be disclosed as part of court proceedings. This includes any oral or written admissions against the parties’ interest, provided they are made in a genuine attempt to settle the dispute between the parties.

The Tribunal

Delays in the Tax Chamber have been a problem for years, and things seem to be getting worse. Official statistics show that in the quarter July-September 2022, the number of outstanding cases in the First-tier Tribunal increased by 52% compared to the same quarter in 2021; 45,000 cases are waiting to be heard or otherwise decided. One way to mitigate or reduce these delays would be to encourage parties to make greater use of ADR.

Rule 3(1) of the Tribunal Procedure Rules provides that, where appropriate, the Tribunal should seek to bring the availability of ADR for the resolution of the dispute to the parties’ attention and facilitate the use of ADR where the parties wish to engage in it. This is compatible with the overriding objective.

In June 2020, the Tribunal published, for the first time, a practice statement entitled “Alternative Dispute Resolution in Tax Disputes”. This provides that the Tribunal will usually stay proceedings to facilitate the use of ADR at all stages of the appeal, “including after HMRC have served their Statement of Case or the parties have exchanged lists of documents or witness statements”. Before this practice statement was published, HMRC’s practice was to refuse to engage in ADR after a Statement of Case had been served. This changed in light of the practice statement, and the only restriction to mediation was whether the nature of the dispute made it suitable for ADR.

HMRC’s guidance

The guidance includes three unexpected changes in policy, explored below.

The exclusive use of an HMRC mediator

Under the new guidance, ADR in tax cases can only be facilitated by HMRC mediators (ADRG01500). HMRC mediators are HMRC officers trained in the principles of mediation and who facilitate many tax mediations. This could be said to have its advantages as it provides easy access to ADR for taxpayers who may not have a preferred external mediator and do not wish to incur the costs of appointing one.

The guidance allows taxpayers to involve an external mediator to work alongside the HMRC mediator. However, the external mediator will not be a co-mediator in any sense of the word. ADRG01200 states that the HMRC mediator “has final control over the mediation process”, and any external mediators will be bound by HMRC’s ADR guidance. This runs contrary to established practice, which was that either an external co-mediator or a single external mediator could be appointed with the parties’ agreement. It is also contrary to what is said in the Tribunal practice statement.

A circumscribed process

The guidance seeks to place the ADR process within strict parameters controlled by the HMRC mediator.

ADRG01300 sets out the “ground rules” for ADR. Among these is a requirement that the taxpayer and their adviser be available for a mediation meeting within 90 days of the start of the process. If the mediator requests more information, the taxpayer must provide this within 15 days. These rules are reminiscent of more formal processes, such as case management directions issued by the Tribunal or the time limits HMRC can impose under its information powers. This is surprising, given that the purpose of ADR is to allow the parties to resolve the dispute in a less formal, two-way process.

While ADRG01400 states that “[e]ach case is different” and “the process may change during the mediation depending on how matters develop”, it also says the format “will be determined by the mediator”, with no indication that any format agreed or suggested by the parties will be taken into account by the mediator. ADRG01600 acknowledges that the parties have ultimate control over the outcome, but it seems the parties will have little or no input into or control over the process. Indeed, ADRG01300 states that if “any” of the ground rules are not followed, “the [HMRC] mediator has the right to end the ADR process”.

This goes against the principle that the negotiations must take place in a flexible manner and on a voluntary basis. While it is important to have a structure in place, the parties should have a say in what that structure looks like. Rule 3(1)(a) of the Tribunal Procedure Rules also makes a non-prescriptive reference to “any appropriate alternative procedure for the resolution of the dispute”, suggesting the availability of a number of ADR procedures rather than a single process controlled by HMRC.

Confidentiality and “tax facts”

Perhaps the most alarming feature of the guidance is its departure from the principle of confidentiality, which, as confirmed by both the CMC and the Tribunal, is a fundamental feature of mediation. A recurring theme is the introduction of the concept of “tax facts”.

ADRG01900 states that “tax facts are not treated as confidential to the mediation” and “are not covered by the ‘without prejudice’ rule”. This means HMRC may rely on tax facts outside the mediation, whether in any Tribunal proceedings or to support assessments issued to the taxpayer.

What is a tax fact? It is not entirely clear. ADRG01700 defines a tax fact as “a fact which has legal and technical implications for a taxpayer’s liability”, including one which “has an impact on any other HMRC tax or duty” (ADRG01300). This definition is not edifying; given the potential implications of disclosing a tax fact, a more comprehensive definition or test would be expected. In any event, the current definition does not deal with the more fundamental issue that to seek an early resolution, parties in a mediation may be willing to accept certain factual positions they would not otherwise agree to.

ADRG01900 provides some examples of tax facts: “the receipt of a payment, the making of a supply, the identity of a customer, the place of supply”. These are, again, not helpful. For example, the place of supply may well be in dispute in a VAT case, and a taxpayer may make assertions or arguments for the purposes of mediation that it may not wish to pursue as part of a Tribunal appeal. Could HMRC then seek to disclose those assertions or arguments to the Tribunal? There is also nothing in the guidance allowing the taxpayer to disclose any statements made by HMRC during mediation to the Tribunal, which creates a significant imbalance in the parties’ negotiating positions.

In addition to statements concerning tax facts, documents provided during mediation may end up being used in future investigations or litigation. ADRG02000 states that “[a]ll documents exchanged during the ADR process are treated in the same way as any other information sent to HMRC and are on the formal record”. This means that “[w]here a document affects the customer’s tax liability and the customer wishes to proceed to litigation following the conclusion of ADR, the mediator will make such documents readily available to HMRC’s legal teams before litigation”. ADRG02100 provides that the mediator’s notes may also be disclosed “[i]f the customer were to share tax facts with the mediator which were hitherto unknown to HMRC and HMRC believes that these facts are ones which the Tribunal should have regard to in coming to its decision”.

This means the taxpayer cannot have an open discussion with the mediator and the case team. There is a danger that the mediation may turn into an opportunity for HMRC to seek information from the taxpayer, who in turn will be reluctant to provide it in case it is used against them. It may also lead to further disputes in relation to disclosure and what constitutes a tax fact, which would be counterproductive and defeat the purpose of ADR.

Overall, there is a concern that the lack of flexibility and confidentiality and the perception of bias by the mediator will deter taxpayers from engaging in ADR, resulting in more disputes being resolved via litigation. This will lead to higher costs for both taxpayers and HMRC, as well as an increase in Tribunal delays.

What can taxpayers and advisers do?

HMRC’s approach to ADR has evolved significantly over time, largely in response to pressure from both the Tribunal and taxpayers. It is hoped that HMRC will take a step back and invite comments on its guidance from tax practitioners and the Tribunal with a view to adopting a more helpful ADR policy in the future.

In the meantime, is it still worth applying for ADR? It is difficult to recommend ADR in light of HMRC’s new position. However, ADR can still be a cost-effective way of resolving disputes or at least better understanding HMRC’s position and narrowing the issues in dispute. If taxpayers and advisers wish to proceed with a mediation, they should bear the following in mind:

• Pushback: HMRC’s guidance does not have the status of law, and the HMRC mediator cannot impose one-sided requirements on the taxpayer without their agreement. If the taxpayer does not agree to a request (for example, because it is inappropriate or more time is needed to accede to it), they should push back.
• Withdraw, if necessary: if the taxpayer is not comfortable with the process or does not feel it is conducive to settlement, they can withdraw at any stage. If there are any concerns surrounding the behaviour of the HMRC mediator or case team, these should be escalated.
• Challenge reliance on “tax facts”: taxpayers should challenge any attempt by HMRC to rely on information provided as part of the ADR process. Taxpayers should also resist any application by HMRC for disclosure of information or documentation mentioned on a without prejudice basis during the mediation.
• Challenge by way of judicial review: in some circumstances, for example, where HMRC issues a new decision based on confidential information shared with the mediator, it may be appropriate to seek a judicial review of HMRC’s decision on the basis that HMRC’s policy to disclose without prejudice information is irrational.

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