Tax deeds and tax warranties

We handle many share purchase agreements (SPAs) and find buyers and sellers are often unclear about the purpose and effect of tax deeds and tax warranties.

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

• The purpose of the tax deed is to protect the buyer against specified tax liabilities relating to periods before completion, even where the seller was unaware of the underpayment.
• The purpose of the tax warranty is to provide contractual assurances about the company’s tax position. The disclosure letter identifies matters that qualify those warranties, putting the buyer on notice of potential risks.

Under a tax covenant, the seller may be required to reimburse the buyer for covered tax liabilities on a pound-for-pound basis. Unlike a warranty claim, recovery under the covenant will not generally depend on proving that the buyer has suffered a corresponding loss, although the precise position depends on the contractual terms.

What is the purpose of tax warranties?

Warranties protect the buyer. If a tax warranty in the Share Purchase Agreement is incorrect, the buyer may be entitled to claim damages, even if the seller relied on advice from an accountant and was unaware of the error. The claim remains subject to negotiated limitations, including time limits, thresholds and financial caps.

Damages generally reflect the loss caused by the breach, which may include a reduction in the company’s value. The buyer must establish its loss and is generally required to mitigate it.

Sellers can qualify warranties by disclosing relevant matters in a disclosure letter prepared in accordance with the agreed requirements. Effective disclosure can prevent a claim in respect of the disclosed matter.

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?

Buyers will often prefer to recover covered tax liabilities under the tax covenant, where the contractual requirements are met, rather than pursue a warranty claim requiring proof of loss. Tax warranties nevertheless remain important for identifying and addressing potential problems.

Why do you need a tax deed?

Although a tax deed may run to 20–30 pages, its central purpose is straightforward: to allocate responsibility for specified tax liabilities arising before completion. The drafting must also address the circumstances in which the seller is liable and the limitations on recovery.

The following are some of the main provisions to consider. The appropriate terms will depend on the transaction, and we can help you assess the available options.

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 specified tax liabilities relating to the period before completion.

The Tax Deed will also deal with the timing of payments to HMRC and the consequences of late payment, including any applicable HMRC penalties and interest and any additional interest payable under the agreement.

There is also usually a “gross up” provision requiring the sellers to pay an additional amount if the payment itself is taxable, so that the buyer receives the agreed net amount, subject to the provision’s terms.

Limitations and exclusions in the tax deed

The tax deed will usually specify circumstances in which the seller’s obligation to pay is reduced or excluded. These provisions are negotiated and may address:

• Whether the relevant tax liability was provided for in the agreed reference accounts;
• Whether tax reliefs available to the buyer or its group should reduce the amount recoverable;
• Whether an action taken by the buyer after completion, or at its request, increased the liability; and
• Whether additional tax arises because of a change in tax law or rates.

How are repayments handled?

A tax deed may provide for adjustments where an over-provision for tax or a tax saving is identified for the period of the sellers’ ownership, subject to the agreed conditions and any required confirmation from the company’s accountants or auditors.

Similarly, if the buyer, the target company or a subsidiary can recover from a third party an amount paid by the sellers under the tax covenant, the deed will generally address notification and repayment arrangements. Where the sellers have funded the recovery process, the buyer may be required to account to them for the amount recovered, in accordance with the agreed terms.

Legal issues arising after a business sale 

Usually, the buyer will manage the target company’s tax affairs after completion. However, responsibility for preparing and submitting outstanding annual accounts and corporation tax returns will depend on the parties’ agreement.

The Tax Deed should set out the parties’ respective responsibilities and cooperation obligations when finalising and submitting outstanding accounts and corporation tax returns.

HMRC investigations relating to pre-sale activity

The Tax Deed will commonly address HMRC enquiries or claims relating to pre-completion periods. Where a tax liability arises, the buyer may seek recovery from the sellers under the tax covenant, subject to its terms.

The deed will usually require the buyer to notify the sellers of relevant tax claims and set out their rights to participate in investigations or appeals. The buyer will often seek to retain control of the process, while the sellers may want the right to investigate the issues and contribute to decisions about any appeal to HMRC.

How will a tax indemnity protect a business buyer?

The tax covenant’s recovery provisions and the procedure for notifying claims may be set out across the tax deed and the Share Purchase Agreement. The documents should be read together to establish how a claim must be made.

Tax claims commonly have longer notification periods than other warranty claims. The applicable period will be negotiated and may depend on the relevant tax and statutory time limits; it should not be assumed that a single period applies to every tax warranty or covenant claim.

The Share Purchase Agreement will usually specify the information required in a claim notice, which may include the amount claimed and the circumstances giving rise to the claim. Compliance with these requirements can be important to preserving the buyer’s rights.

We provide specialist corporate legal support to buyers and sellers, combining corporate and tax expertise with a practical, cost-conscious approach. Please contact us to discuss your transaction and how we can help.