M&A Tax liability insurance: Protecting a deal from uncertain tax costs

What is tax liability insurance?

Tax liability insurance is designed to transfer a known, but uncertain, tax liability from a company’s balance sheet to an insurance company. The insurance indemnifies the policyholder for financial loss arising from a successful challenge from a tax authority, removing uncertainty around potential tax liabilities.

For M&A transactions, policies are available either pre- or post-transaction. Tax liability insurance is also available on a stand-alone basis, for example, as part of an intra-group or pre-initial public offering (IPO) reorganization.

Specific tax coverage can include:

• Defense or contest costs
• Additional tax deemed due to tax authorities
• Interest, fines and penalties (to the extent insurable)

Coverage is available across a wide range of jurisdictions and industry sectors. When considering requests for tax liability coverage, insurers will look at residual risks relating to known tax issues as well as the tax structure of the acquisition itself.

Who should buy tax liability insurance?

Tax liability insurance is normally bought in the context of investments or M&A transactions where there are questions over the validity of a tax position, usually uncovered during the due diligence process.

Benefits of tax liability insurance

A tax liability insurance policy can facilitate a transaction by:

• Providing certainty and managing negative financial impacts by transforming potential tax liability into a quantified insurance cost, allowing the issue to be accounted for precisely
• Enhancing or preserving the value of a business or a particular asset
• Enabling a solution when parties do not want (or do not have time) to obtain prior clearance from tax authorities

Examples where tax liability insurance can be provided include:

• Availability of substantial shareholding exemption(s) in relation to a disposal of shares
• Categorization of asset sale versus business sale
• Residency issues
• Debt for equity swaps
• Secondary tax liabilities
• Stamp duty land tax group relief
• Tax charges arising on the disposal of loan notes
• Tax-exempt demergers
• Withholding tax on overseas dividend payments
• Trading versus investment risk
• Tax residency
• Transfer pricing