As the revenue authorities around the world refocus their efforts on adjustments and enforcement, they are similarly focused on gaining efficiency in the face of reduced budgets and increasing responsibility. One approach to achieving efficiency in the tax disputes resolution process is the use of alternative dispute resolution (ADR) methods, to avoid costly, time consuming and resource depleting litigation. ADR allows the taxpayer and the revenue authority to come together to actively seek resolution. While different jurisdictions have different approaches, the concept is gaining global appeal. Companies should keep these programs in mind when planning their response to tax audits and assessments.
In a recent webcast, Sharon Katz-Pearlman led a panel discussion with four Tax Dispute Resolution and Controversy Services leaders from across KPMG International's network of firms. Countries represented included three with established programs – United Kingdom, United States and Australia, along with Germany, whose judicial mediation process is relatively new. Key aspects of the ADR systems in these four countries are summarized below.
In 2009, as HM Revenue & Customs (HMRC) was becoming ever more burdened with a backlog of tax appeals, there was a growing sense that many tax disputes could be resolved through collaboration between the taxpayer and the tax authority. In that year, new Tax Tribunal rules were introduced requiring the Tribunal in such cases to inform parties of the availability of alternatives for resolving the dispute. In 2010, the HMRC created a Dispute Resolution Unit (DRU) to coordinate development of this new approach.
The unit worked to develop a Litigation & Settlement Strategy, which was introduced in 2011. Along with specific guidance on new ADR procedures, the DRU broadened the ADR approach not only to support facilitated agreements to resolve disputes but also to help the parties prepare for litigation, which would ultimately reduce litigation costs if ADR efforts did not succeed. A pilot test of the program was conducted in 2011–13 with participation and input of representatives of KPMG in the UK and other professional accounting firms.
ADR is now a formal HMRC procedure for tax dispute resolution, and it is used in a growing number of cases. The approach is considered appropriate in cases where the parties are at an impasse and litigation might have to be considered. ADR can be used not only to resolve cases with a range of possible outcomes (e.g., transfer pricing, valuations) but also 'all or nothing' cases to test whether there are alternatives to binary outcomes or to determine which party's argument is strongest. However, ADR is not used to resolve cases involving avoidance schemes or issues for which HMRC has a clear policy position that cannot be compromised.
The HMRC ADR process is as follows:
To date, feedback on the HMRC's ADR program has been overwhelmingly positive. Participants say mediation has greatly increased the parties' prospects of reaching a negotiated settlement. HMRC and tax advisors have benefited from their investments in CEDR training for their professional teams. Compared to pursuing a formal appeal, ADR usually results in a quicker, less costly outcome.
The US Internal Revenue Services offers a number of ADR mechanisms that can be employed at various points in the assessment and appeals process. The features of the most prominent of these mechanisms are highlighted below.
Introduced about 10 years ago, FTS is the most popular IRS ADR mechanism. The approach is available to all Large Business and International Division taxpayers and has been extended to smaller taxpayers and tax-exempt entities. Taxpayers can request FTS once an issue is fully developed (e.g., after a Form 5701 (Notice of Proposed Adjustment) but before a 30-day letter has been sent. The examination team must also agree to FTS and, in the experience of KPMG in the US, most requests are accepted.
FTS usually involves a one or two-day informal mediation process. With few set rules, parties have considerable leeway to agree on how the ADR will unfold. The mediator is usually a senior appeals officer selected jointly by the IRS team and the taxpayer. In some cases, the IRS simply chooses which Appeals Officer will be assigned to the proceeding.
The goal of FTS is to reach resolution within 120 days of acceptance. Both factual and legal issues can be negotiated. Settlements can be based on the hazards of litigation, allowing the examination team to weigh potential litigation costs as it negotiates settlement.
A key advantage of FTS is that it can occur while the issue is still with the Examination Division, thus, "hot interest" (interest on tax in dispute) will not accrue while the FTS proceeds. Another advantage is that taxpayers can withdraw from the procedure at any point without losing their traditional rights to appeal.
The IRS Examination Division is charged with examining returns and proposing adjustments. Taxpayers have historically had the ability to appeal proposed adjustments to the Office Appeals, which has a good record in reaching agreements with taxpayers in these cases.
Appeals officers undertake an independent review of the disputed issue and attempt to effect a settlement or resolution based on the perceived hazards of litigation to both parties. Appeals officers will not consider or raise new issues, but they can send the case back to the examination team for further development. New information cannot be provided at the appeals stage either. The views of company witnesses or other facts must be presented to the examination team before the appeal or the new information will not be considered.
According to the IRS, traditional appeals are settled in 80 percent of cases considered.
The process for early referrals is similar to traditional appeals. Here, the appeal takes place while the audit is still in process. When an issue develops before the audit concludes, the taxpayer and examination team can decide to escalate an issue for consideration by the Office of Appeals while other audit issues are still being decided. Early referral was more popular before FTS was introduced, but it remains a viable option.
Post-appeals mediation is a non-binding process available where a taxpayer cannot reach an agreement with an appeals officer. The process is voluntary, so the IRS must accept a taxpayer's request to proceed.
In this process, the appeals officer involved in the case acts as an advocate for the government and can invite the examination team and/or IRS counsel to participate. Thus, the prospects for success can depend on the appeals officer's openness to a mediated settlement. The taxpayer can request that an outside mediator be used in the case but must pay for all costs associated with the outside mediator. The IRS will appoint an internal mediator as well (usually a senior appeals officer from another part of the country). The mediator or mediators do not have authority to force a resolution or make a decision. The role of the mediator is to bring the parties closer together and hopefully assist them in crafting a resolution acceptable to both parties. If an agreement is reached, a Form 906 closing agreement is executed. If not, litigation is the taxpayer's final option.
Post-appeals arbitration is a process whereby the taxpayer and the IRS agree to be bound by the decision of one or more third parties from within the IRS or externally. This approach can be requested for issues in the Appeals administrative process after settlement negotiations are unsuccessful.
In practice, this mechanism is rarely used. The procedure is costly and operates much like a court proceeding. Further, once the arbitration is complete, the taxpayer has no further right to appeal and will be bound by the arbitrator's decision.
Available to protect taxpayers from double taxation under virtually all US tax treaties, bilateral competent authority proceedings are being used more frequently as cross-border tax disputes continue to climb, for example, over transfer prices and permanent establishment determinations.
Some recent treaties also provide for formal arbitration. For example, the US-Canada tax treaty provides for 'baseball arbitration', under which both parties present their arguments and a panel of three arbitrators chooses the best argument, with no negotiation or consideration of alternatives.
Australia has had a tax appeals system in place that has worked fairly well for over 30 years, providing for both administrative and judicial reviews of tax issues in dispute. More recently, however, the amount of adjustments, objections and cases resulting in litigation has increased for large business taxpayers. This situation created disharmony between taxpayers and the Australian Tax Office (ATO) and prompted the former Commissioner of Taxation to call for an independent system of tax review.
Following his appointment in January 2013, Australia's current Commissioner of Taxation, a former senior KPMG tax partner, has made quicker resolution of technical issues and tax disputes a key priority. Among other things, he introduced an independent ATO review function for large businesses, which is separate from the compliance and review function. He has also promoted more open relationships with taxpayers and the use of in-house facilitators and third parties, such as former judges, for early neutral evaluation or mediation.
Additionally, the tax authority is now obliged to use or at least consider ADR in tax disputes by law. As of 2005, the country's good management rule requires agencies, including the ATO, to try to avoid, prevent or limit litigation by considering and taking part in ADR where possible. Since 2011, before legal proceedings can begin, taxpayers and the ATO must file a 'genuine steps' statement outlining the steps they took to avoid litigation. Unlike other countries, this puts the onus to consider ADR on the tax authority, not the taxpayer.
ADR options currently available include:
Under Australia's Code of Settlement Practice, the ATO must take a principles-based approach to settlement. It cannot forgo tax properly payable, depart from precedential APT positions, or agree to settlements that do not align with stated technical positions. The ATO will consider entering ADR when:
Australia's new ADR procedures have produced good results in achieving resolutions much more frequently and much earlier in the objection and appeals process.
ADR in Germany is relatively new, having been introduced in German law in 2012 on the country's transposition of the 2008 EU Directive on certain aspects of civil and commercial matters. Although the Directive does not expressly apply to tax, customs and administrative court matters, the German legislator decided to introduce mediation as an option in its 2012 Mediation Act.
Under German law, judicial mediation is not mandatory; its use is left to the discretion of the courts. In cases of tax disputes, the courts must decide through their councils whether mediation should be made possible and which judges should act as mediators (which are known as 'quality judges'). Of the 18 German fiscal courts, 15 of them currently allow a mediation procedure.
Mediation is a structured, non-public process in which the participants work with the quality judge to resolve issues voluntarily and autonomously in order to achieve a satisfactory solution for all parties. Quality judges must undergo extensive training, and they must be strictly neutral in mediating the conflict: they cannot make decisions or offer advice.
In deciding whether to allow mediation in their courts, judges and others questioned whether the tax law is open as a public right to intervention of negotiated solutions. As a result, no tax claims can be negotiated or settled by agreement. Among other things, mediation may be pursued for:
Further, mediation can only be practiced at the tax courts as courts of first instance. No mediation is permitted at the Federal Fiscal Court, which is a pure Court of Appeals on legal matters. Once mediation has commenced, court proceedings and accruing court fees are suspended. Once consensus is reached, the mediation agreement is recorded by the court and is binding on all parties.
To date, no statistical data is available to determine the success of this mediation process. However, it is questionable whether the mediation process is more effective than the traditional method of amicable dispute resolution allowed under German tax law.