How you could end up paying HMRC’s legal costs

A recent case has brought to light a situation in which taxpayers were required to pay HMRC’s legal costs for defending the case as well as the VAT which was under dispute. Rulings about the payment of costs are made by the first-tier tax tribunal (FTT), although in general they don’t have power to make the losing party pay costs for the other side. There are two specific sets of circumstances where they can do this, however.

The first is during a ‘complex case’, where the winning party takes everything and the losing party is liable for the costs for both sides. In cases between taxpayers and HMRC, the taxpayer can opt out of footing the bill for legal costs within 28 days of notification that the case has been deemed complex. This takes away the risk to the taxpayer if they end up losing the case, unless they fall foul of the second scenario, known as the ‘unreasonable behaviour’ rule.

Under this rule, “if the [FTT] considers that a party or their representative has acted unreasonably in bringing, defending or conducting the proceedings,” then they can award costs against either party. This rule isn’t limited to complex cases, but the FTT has to allow the party the opportunity to make representations before an order is made against them.

In complex cases, the decision of whether or not to opt out should be made by considering the odds of winning the case, as well as the tax at stake and the likely costs to be incurred by both parties. If the odds don’t look favourable to the taxpayer, opting out is the best option to go for in order to limit the potential cost if they lose. If the taxpayer believes their case is strong, opting in allows them to essentially bet on the likelihood of winning and have HMRC pay the taxpayer’s costs if they are successful.

In the case in question, the taxpayer applied for an initially simple case to be re-categorised as complex on the first day of the hearing, and stated that they didn’t intend to opt out of liability for costs. However, after the case was re-categorised, they applied to opt out but when they lost the case, they were ordered to pay all costs.

The taxpayer argued that they had acted in line with the rules and had not acted unreasonably, so they should not be liable for the costs. HMRC countered that the re-categorisation had been accepted on the basis that they would not opt out, and that their subsequent application to do so was an abuse of process. The case was passed on to the upper tribunal, who ruled that the taxpayer’s application to opt out was invalid, making them liable for all costs.