Tax Deed
Deed of Tax Indemnity
A Tax Deed is customarily entered in conjunction with the share purchase agreement. The Deed is usually an unconditional indemnity in respect of tax liabilities not provided for and factored into the purchase price. However, its precise terms need to be examined in order to confirm its effectiveness. It may be that some contingent liabilities which are known to the buyer are covered on the basis that the seller takes the risk on the matter concerned.
The tax deed is usually circulated with the principal draft documents from the outset. Many of the provisions of the deed are in standard and commonly used terms. There may be negotiation on particular terms as the transaction proceeds. Commonly they replicate the tax warranties in the share purchase agreement. There may be substantial replication between them.
The tax indemnity is usually drafted in favour of the buyer. Previously, it was common to provide the indemnity in favour of the company. This has certain adverse tax consequences and is not now usually done. Tax covenants will generally be given by the same sellers who give the general warranties.
Scope I
The Tax Deed is usually an indemnity dealing with unexpected tax claims arising after completion due to pre-completion transactions and events.
The tax indemnity or “covenant” or “deed” will cover pre-completion tax liabilities which are not dealt with in the accounts or do not arise in the normal course of trading or not otherwise disclosed. It will also cover cases where tax reliefs were assumed to be available at closing but which prove not ultimately to be available. If there are identified tax risks or liabilities, the tax covenant may cover them specifically.
The seller will generally seek to exclude liability for liabilities arising in the normal course of business, those provided for in the accounts, those arising by retrospective changes in the law or caused by voluntary acts of the buyer.
Scope II
Where the sold company is a member of a group, it will be necessary to include provisions to deal with the implications of the company leaving the group.
A seller will seek to impose some limitations on the tax indemnity. There will generally be a maximum liability cap usually for the amount of the purchase price. The liability period is normally for 4 to 7 years. Unlike the case of warranties, buyers will rarely accept any limitation of liability under the covenants.
Tax covenants usually provide a mechanism for the seller to take control of the conduct of the claim given rise to liability. The seller would normally be notified as soon as reasonably practicable.
Tax Warranties v Tax Deed
Commonly the share purchase agreement will also contain tax warranties. Commonly there is overlap and duplication between them. Unlike the indemnity, the warranties are subject to the contractual obligation to mitigate.
The effect of tax warranties may be reduced by disclosure of adverse matters which contradict their terms. It is not customary for disclosures to limit the effect of the tax deed. This is in contrast to the position with the warranties in the share purchase agreement.
Part of the objective of including tax warranties is to secure that a claim (on a warranty) operates to reduce the price for the buyer and the seller. Any compensation received should be a price reduction and not be subject to capital gains tax for the buyer. It reduces the base price of the shares for future capital gains tax purpose. From the seller’s perspective, the reduced consideration should reduce its capital gains tax liability marginally.
The tax deed of indemnity is usually given in favour of the company itself. The warranties are usually given by the seller to the buyer. In some cases, the buyer may be included as a beneficiary of the indemnity.
Extent of Liability
The indemnity usually provides a comprehensive definition of taxation including Irish taxation, overseas taxation and all other taxation liabilities, arising including interest and penalties on arrears of tax. The definition will generally extend to all tax obligations and liabilities. It will also include losses or reductions of tax repayments and withdrawals of relief provided for or assumed to be available in the accounts.
Typically, the indemnifiers will be made liable for costs associated with the tax liability, including costs for resisting, settling and paying the tax liability including, in particular, the associated professional costs.
It is often provided that if withholding tax is required to be paid on the indemnified amount by law, then the warrantor / seller must gross up the sum so that the company / buyer receives the net amount required to compensate it if the withholding tax did not apply. This clause seeks to ensure that the company / buyer is put in the same position as he would have been, had the payment not been subject to tax. The grossing-up clause increases the seller’s potential liability further.
Other Substantive Terms
An indemnity will specify its duration. A non-tax indemnity will commonly apply to liabilities which arise within a specified period, commonly two to three years., which relate to the pre-completion trading and matters. The tax warranties included in the share purchase agreement are usually subject to the same longer indemnity time limit as the tax indemnity.
The duration of the tax indemnity is usually longer than for other breaches of warranty claims; usually, four to six years, reflecting the four year period in which Revenue can reopen or review a return.
In the case of negligence or fraud, a longer period will apply. The tax deed will usually continue to apply in such circumstances. The terms of each extension should be the similar or the same.
Limitations
A number of common and relatively standard limitations are usually inserted in the tax indemnity. They may be a matter of negotiation in the particular circumstances. They include the following matters in respect to which the indemnity does not apply.
- tax provided for in the accounts either by way of provision or charge;
- tax arising from an act or omission of the buyer after completion;
- tax arising from changes in law and practice after the completion with retrospective effect;
- increases in tax rates arising after completion with retrospective effect;
- tax arising due to a failure on the part of the company to submit tax returns properly and on time etc.;
- tax arising due to a change in accounting policy, accounting date, or practice adopted by the buyer after completion;
- tax covered by the tax warranty;
- tax arising due to the failure by the buyer to follow the specified conduct of claims procedure;
- tax due to the cessation of trading or winding up after completion;
- tax which is otherwise recovered and causes no loss to the company or buyer;
- tax arising from an event in the normal course of business since the last accounts date to completion, e.g. trading income.
Various other Limits
The indemnity will usually exclude tax arising from post-completion dividends, liability arising from contracts other than at market rate and the liabilities arising from the cessation of group membership undertaken by the buyer.
There may be a De minimis claim level. Liability may cease unless the claim is made and pursued within a period after notification.
There may be confirmation that there can be no double compensation by way of claims under both the share purchase agreement and deed of indemnity for the same loss. The seller may require that a claim must be made first as a breach of warranty before being taken under the tax deed.
The indemnity may not be applicable to identified contingent specifically identified and excluded from its effect. Any overprovision for tax in the accounts may be offset against claims.
Conduct of Claims / Procedure
The warrantor /seller may be permitted under the deed to have the conduct of taxation claims, subject to giving the necessary security. It will be obliged to keep the seller advised. The buyer is usually obliged to notify the seller of the claim as soon as possible. The seller is then entitled to have the conduct of the claim by way of dispute appeal, settlement, defence etc.
The conduct of claim provisions applicable in the tax deed will usually apply to the tax warranties in the share purchase agreement.
Separately, the buyer may be precluded from settling a taxation claim without the seller’s consent. The buyer is not usually required to take an appeal unless there is an opinion of tax Counsel as to the likelihood of success. Security is required from the seller
The buyer may be obliged to seek recovery from third parties where possible in which event the seller is liable only for the uncovered amount.