When does tax litigation cross the line? Indemnity costs outcome in the First-tier Tax Tribunal

Costs in tax litigation often catch even experienced advisors off guard. Unlike other areas of civil litigation, where costs consequences are ever-present and a continuous strategic consideration, proceedings before the First-tier Tax Tribunal (Tax Chamber) (“FTT”) are often approached with less emphasis on potential costs exposure.

The recent decision in Governance Ministries v HMRC [2026] UKFTT 371 (TC) (“Governance Ministries”) is a stark reminder that the FTT will not hesitate to depart from the standard basis and award costs on the indemnity basis where a party’s costs and conduct justifies it. The case illustrates not only when indemnity costs may arise in tax disputes, but also how the nature and purpose of such costs in the FTT can differ significantly from their use in the High Court.  

When withdrawal crosses the line

The underlying facts of Governance Ministries are striking and are integral to the outcome. HMRC withdrew from a nine-day listed appeal just minutes before the deadline for filing its skeleton argument. By that point:

• the taxpayer had incurred substantial preparation costs (£780,000);
• the hearing window had been allocated; and
• both parties were, for all practical purposes, at the door of trial.

The Tribunal approached the issues using the framework set out in Tarafdar v HMRC [2014] UKFTT 362 (TC), which required the Tribunal to consider:

• whether there was a proper basis for withdrawal;
• whether the decision could and should have been made earlier; and
• whether the timing of withdraw amounts to unreasonable conduct

In Governance Ministries, the Tribunal’s answer to all three questions was a clear “yes”. HMRC had long been in possession of the material needed to evaluate the merits of its case and the late-stage withdrawal was not driven by genuinely new developments. Instead, it represented a failure to engage with the merits at an earlier stage, resulting in unnecessary costs being incurred by the taxpayer. This was conduct that the Tribunal found to have crossed the line into unreasonable conduct.

The Legal Test: “out of the norm” in a tax context

The Tribunal reaffirmed the orthodox test from Excelsior Commercial (2002) that indemnity costs require conduct that was “out of the norm.” But what constitutes “the norm” differs markedly between civil and tax litigation.  

In the High Court, the “norm” is already adversarial and costs sensitive as parties to litigation are expected to constantly assess risk, explore and engage in settlement and comply strictly with procedural timetables and disciplined by the Civil Procedure Rules and the Overriding Objective. Indemnity costs remain exceptional, but they sit within a system that assumes constant assessment of risk, active case management and strict procedural compliance. In practice, indemnity costs are reserved for conduct that is “out of the norm” or unreasonable to a high degree.

By contrast, in the FTT many cases proceed on a no-costs or limited costs basis, the procedural culture is typically less adversarial, and there is often greater latitude for parties to refine their case as it evolves. Consequently, this means the baseline for “normal” conduct is materially different and conduct must represent a more significant departure from reasonable behaviour to justify indemnity costs that might be required in civil proceedings.

In applying Tarafdar in Governance Ministries, the Tribunal found:

• HMRC was expected to keep its case under continual review;
• The supposed trigger for withdrawal contained nothing fundamentally new; and
• HMRC had almost 18 months to reassess its position.

This combination is why the Tribunal found HMRC’s unreasonable conduct to be sufficient to justify “indemnity basis throughout.”

Indemnity Costs as a disciplinary tool

One of the key takeaways from this decision is the function of indemnity costs in the FTT. In other areas of civil litigation, indemnity costs serve a dual purpose, namely to 1) provide enhanced compensation through the removal of the constraints of proportionality and 2) procedural consequences, often linked to mechanisms such as Part 36 offers.

However, in the FTT, there is a shift in emphasis due to costs not necessarily being a strategic consideration. Indemnity costs operate primarily as a judicial response to conduct that undermines fairness in the process. In Governance Ministries, the Tribunal placed emphasis on context: the timing of HMRC’s decision making, the absence of a satisfactory explanation and prejudice and overall risk caused to the taxpayer.  This appears to align indemnity costs in tax cases more closely to a disciplinary tool, rather than a purely compensatory one.

The Elvanite principle

It is also useful to consider the “Elvanite” principle alongside the Governance Ministries decision. In Elvanite Full Circle Ltd v Amec Foster Wheeler [2013] EWHC 1643 (TCC) Coulson J made clear that where indemnity costs are awarded, costs management orders remain the starting point. However, the indemnity basis allows the court to depart more readily from the costs budgeting constraints without removing the court’s oversight.

Unlike in other areas of civil litigation, the FTT does not operate a formal costs budgeting regime. With fewer structural constraints on costs recovery from the outset, the shift from the standard basis to the indemnity basis can have an immediate and significant financial impact, increasing recovery in an already relatively unconstrained landscape.

Consequently, the threshold for “out of the norm” conduct in the FTT is all the more important as it is the primary mechanism by which the Tribunal can control costs.  

The practical impact of standard v indemnity basis:

In Governance Ministries, the indemnity basis costs order resulted in a substantial interim payment on account of costs of £400,000 (approximately 51% of the £780,000 stated as having been incurred by Governance Ministries). The Tribunal emphasised that a lower figure would not properly reflect likely recovery on the indemnity basis, demonstrating the substantial difference between the standard and indemnity basis. In practice, this means that for indemnity basis assessments, the requirement of the costs bearing a proportionate relationship to the work done is essentially removed, leaving the need only for the costs to be “reasonable” with reference to CPR 44.3 and doubt resolved in favour of the receiving party. A standard basis assessment would require proportionality consideration and with any doubt being resolved in favour of the paying party. The financial consequences are therefore not marginal; they can be substantial.

Conclusion: A sharper costs landscape in the FTT

The Tribunal’s message is clear; continuing to prepare for trial while harbouring doubts about the strengths of your case is a high-risk strategy, with significant cost implications. Unless driven by genuinely new and material developments, late withdrawal remains one of the clearest hallmarks of unreasonable conduct, potentially resulting in the paying party on the end of an indemnity basis costs order. Overall context, however, is key in determining what is “out of the norm”.

The decision also reinforces a consistent principle across jurisdictions that, where conduct falls outside the bounds of reasonable litigation behaviour, courts and tribunals will respond by removing the usual protection on costs recovery.

For practitioners, including accountants and tax advisors, the decision provides helpful guidance into the Tribunal’s stance on costs and reasonable conduct. Costs are not just a consequence of losing - they are a consequence one’s approach to litigation.

If you have any questions regarding this blog, please contact Tabassum Zahedi in our Dispute Resolution team or Holly Shaw in our Costs team. 

About the authors

Tabassum specialises in tax disputes, investigations and risk management.

Holly is an Associate in the Costs team. Holly’s practice covers a wide range of civil litigation, with a particular focus on costs in defamation and privacy proceedings.