Unjust enrichment and VAT disputes: A case for Alternative Dispute Resolution

In a recent case, MHA were asked to assist a client who had become embroiled in a dispute about ‘unjust enrichment’. The dispute was ultimately resolved through alternative dispute resolution (ADR) and illustrates the value of this form of engagement with the tax authorities.

The role of ADR in resolving VAT disputes

ADR is designed to avoid the costs and uncertainties of tax tribunals. It involves a facilitated negotiation between the disputing parties, aiming to resolve issues without needing to escalate to court. HMRC appoints a facilitator who organises the process by liaising between HMRC and the taxpayer and then chairs a meeting (usually virtual) at which the dispute is discussed with the aim of reaching an agreed settlement.

The ADR process

The meeting typically begins with each party presenting their opening statements, outlining the nature of the dispute, their respective positions and what they hope to achieve from the process.

The process works best by encouraging open dialogue. After the initial statements, the parties can break out into separate rooms to consider their positions, ask questions, and regroup to discuss further. The facilitator plays a key role in challenging both sides to consider the strengths and weaknesses of their arguments, which can often lead to a resolution.

One significant advantage of ADR is that it is a “without prejudice” forum, meaning discussions during the ADR cannot be used in court if the dispute escalates. This encourages more candid dialogue. Businesses should still be cautious; if something particularly concerning is revealed, HMRC is obliged to act on it.

ADR is particularly effective when there’s room for negotiation or where evidence can be better presented in a discussion than through prolonged correspondence.

In this particular case, the business was initially denied a VAT refund claim by HMRC who used the defence of ‘unjust enrichment’ to deny a reclaim for overpaid VAT. Unjust enrichment is a concept that arises when a business incorrectly charges VAT on a product or service that should have been exempt, or zero-rated. The business may seek to reclaim the VAT from HMRC, but where HMRC can show that the overcharged VAT had been passed on to customers, they will invoke the defence of unjust enrichment to deny the business’ profiting unfairly from the VAT reclaim.

Successfully reclaiming VAT where HMRC have invoked unjust enrichment is challenging. To succeed, a business must either demonstrate that the VAT was not passed on, or that the business has been materially damaged by incorrectly charging VAT. This often requires deep dives into the business’s financial position and the economics of the market in which it operates, examining how the incorrect VAT charge affected profitability, and presenting this evidence convincingly.

Due to the complexity many cases end up in the Tax Tribunal. Tribunal proceedings are costly, uncertain, and can drag on for extended periods, making them an unattractive option for businesses. ADR offers a way to potentially avoid these pitfalls by facilitating a discussion between the business and HMRC to reach a mutually acceptable resolution.

Through the ADR process, in this case the business was able to present detailed evidence of the financial impact of incorrectly charging VAT, including how it affected profitability. This evidence was critical in persuading HMRC to reconsider their position, although there was inevitably some negotiation over specific points.

ADR outcomes and HMRC’s approach

The outcome of an ADR session is documented in a Record of Outcome, which details the agreements reached and the next steps. If a resolution is achieved, it can save both parties the time and expense of a tribunal. In this case, the outcome was a payment by HMRC to the business, with the business withdrawing its appeal to the tribunal.

HMRC is supportive of ADR as it aligns with their Litigation and Settlement Strategy (LSS), which promotes a collaborative approach to resolving disputes. However, ADR is not suitable for all disputes. For example, when the issue is a straightforward legal question, such as whether VAT is due on a specific type of supply (e.g., the infamous marshmallows debate), it typically requires a tribunal decision.

The cost of ADR

Participating in ADR is significantly less expensive than going to tribunal: there are no fees for the process itself, and the only costs incurred are those charged by professional advisors. In contrast, tribunal cases require extensive preparation, including assembling case law and documentation, preparing skeleton arguments and attending a hearing at which the business owners or employees may be required to appear as witnesses. Tribunals are time-consuming, costly and stressful.

HMRC’s ADR success

HMRC’s annual report for 2023-2024 shows that ADR is not only a viable alternative but also an effective one. Out of 367 cases closed during the year, 307 were resolved through ADR, reflecting an impressive success rate of 83.7%. These statistics underscore the effectiveness of ADR in resolving tax disputes, making it a valuable option for businesses facing complex tax issues.