Tax deeds and tax warranties

We handle many share purchase agreements (SPAs) and find buyers and sellers worry about the tax deed and tax warranty as they do not understand what it all means. 

Tax deeds and warranties are a common part of share purchase agreements.

• The purpose of the tax deed is to ensure the buyer does not lose out if it later comes to light the seller underpaid tax (even if it did so unwittingly) before the buyer took over.
• The purpose of the tax warranty is for the seller to warrant everything is as they say it is. The disclosure letter usually covers tax warranties and carves out any risk areas so that the buyer is on notice.

The effect is that the sellers promise to pay on a pound for pound basis all liabilities owed.  But because there is a promise to pay this amount, there is no need for the sellers to even prove they have actually suffered loss and claim damages.  They just need to show there is a tax liability which they are entitled to recover under the terms of the deed.

So, ask yourself:

• Buyers – Is your tax deed comprehensive enough?
• Sellers – How can you limit liability as much as possible?

What is the purpose of tax warranties?

Warranties protect the buyer. If the seller gives warranties in the Share Purchase Agreement which are not 100% correct (even if the seller did not know it was incorrect because they relied on advice from their accountant for example) then subject to some limits (time periods, thresholds and limitations - which are negotiated) the buyer can claim damages from the seller.

The damages will be equal to the loss the buyer has suffered because the company is worth less than is expected.  The buyer will have to prove its loss and has a general duty to mitigate.

There is one way sellers can protect themselves, by formally “disclosing” anything that makes any warranty not completely accurate in a letter (referred to “disclosure letter”)

If fully disclosed in the specified form of letter the seller is not liable.

Key points for tax warranties

• Buyers – Are you warranties sufficiently broad? Are the limits too restrictive?
• Sellers – How can the warranties and limits be narrowed? Do you have a detailed disclosure letter in place to offer protection?

As a buyer will always prefer to claim under the covenant to pay for any tax matters (because it is easier to recover the full amount £ for £ and it will not have to prove loss), the role of the tax warranties is primarily to flush out if there any problems.

Why do you need a tax deed?

In essence the Tax Deed is very simple but it is easy to lose track of that as a typical document is often 20 to 30 pages long.

Here is a summary of the main areas to include in tax deeds.  There are many other areas to think which we have not mentioned.  We can help you fathom out the way forward.

How does a tax deed work?

The heart of the tax deed is that the sellers agree to pay to the buyer on a pound for pound basis the amount of any tax liability arising pre-completion.

The Tax Deed will also deal with when the claim must be paid to HMRC.  It will also state what will happen if it isn’t paid on time.  (There may be HMRC penalties and interest and the buyer may charge interest on top of this).

There is also usually a “gross up” provision which says that, if the amount paid to the buyer is subject to tax, then the sellers will pay the buyer an additional amount, so that the amount the buyer receives is the same the buyer would have got if there hadn’t been any tax payable on it.

Limitations and exclusions in the tax deed

Limitation and exclusion clauses in the tax deed will  generally set out when the covenant to pay does not apply.  The tax deed will be negotiated but are likely to include things like:

• was there a provision for the relevant tax in the Company’s accounts that are being used as a reference point?
• are Tax Reliefs available to the buyer (or its group) that should be used?
• did something the buyer do something after completion or ask the sellers to do something that increased the tax liability?
• what happens if there is more tax that needs to be paid either because of a change in law or the rates of taxation?

How are repayments handled?

Yes, sometimes!  If it can be shown that there was an over provision made for tax for the period of the sellers’ ownership or there is a saving (and the Company’s then auditors/accountants agree) provision is needed in the tax deed. There are usually provisions in the Tax Deed that deal with how these over provisions/savings will be applied.

Similarly, if it transpires that the buyer, the target Company or any of its subsidiaries can recover an amount paid by the sellers under the covenant to pay from any third party, then the Tax Deed will usually say that the sellers need to be notified. If the tax deed covers the cost of any claim against the third party, the buyer can be required to get that money back so that the sellers can be compensated.

Legal issues arising after a business sale 

Usually, the buyer will have responsibility for and conduct of all tax affairs of the target Company post-completion.  But, where annual accounts and corporation tax returns still need to be dealt with who does what will be a matter for negotiation.

The Tax Deed, as part of the share sale transaction, will set out who will be responsible and what co-operation there will need to be between the parties in the finalisation and submission of the relevant accounts and corporation tax returns.

HMRC investigations relating to pre-sale activity

Another thing the Tax Deed will also deal with is what happens if any claim is made against the Company by HMRC.  Tax claims from HMRC may trigger a tax liability which the buyer may seek to recover from the sellers.  Generally, there will be provisions in the Tax Deed whereby the sellers need to be informed of any tax claim and they will have some input into if and how any appeals to HMRC should be made and by whom.  Usually, the buyer will want to lead on this. Often the sellers or their accountants will reserve an opportunity to investigate the relevant matters and have some input into any appeal to HMRC.

How will a tax indemnity protect a business buyer?

Interestingly, the actual provisions about how the buyer can claim under the Tax Deed and the process for giving notice of a tax claim are not usually in the Tax Deed.  It is more usual to include the tax claims in the warranty  section of the share purchase agreement.

Tax warranties are should cover at least six or sometimes seven years.  For other warranties, the period will be negotiated but is usually one to three years maximum.

The provisions relating to giving notice of a claim in the share purchase agreement typically will be very specific on what details need to be given in the notice of the claim (for example, amount  and matters giving rise to the claim).

We are specialist corporate lawyers - what sets us apart is that we are niche, provide value for money, are flexible and have specialist tax expertise. Please do get in contact to discuss how we can help.