Tax Liability Insurance – A strategic tool during unsettling times

Christopher Waddington : Senior Tax Underwriter

Christopher Waddington

Senior Tax Underwriter

Tax liability insurance is a strategic tool utilized to transfer responsibility for tax contingencies from the insured to the insurer, whether in the context of a mergers and acquisitions transaction or otherwise.  Cover can provide certainty to buyers and sellers during transactions by transferring financial risk from potential material tax exposures to the insurer, thus allowing the parties to move forward with greater confidence.

Tax liability insurance can offer comfort to address various transactional issues:

  • Providing peace of mind to a company/individual that they will not be exposed to a historical tax position;
  • Removing a contentious tax issue from the negotiating table on an acquisition;
  • Improving a bidder’s offer by not requiring protection for a potential issue in the target company;
  • Allowing the release of funds from escrow; and
  • Enabling investment funds to return proceeds to investors.

However, these are unprecedented times, giving rise to particular challenges for both taxpayers and tax authorities worldwide.   Below are some specific scenarios where tax liability insurance can offer a potential solution to address tax risk in the current climate of market uncertainty:

Alternative to tax rulings:

In many jurisdictions, the process to obtain a binding tax ruling from the tax authority is currently protracted.  Tax insurance can provide a viable alternative for obtaining certainty where seeking a binding ruling may not be possible within the deal timetable.

Group restructuring and reorganisations:

Many groups may be under distress due to a reduction in trading activity and revenue.  As a result they may look to, or be required to, implement a restructuring (e.g. in preparation for a spin-off of unprofitable or non-core business), debt-for-equity swaps or debt waivers.  Such actions could potentially trigger significant tax consequences, such as capital gains taxes, transfer taxes and corporation taxes. For example, there may be uncertainty in the application of tax neutral reorganisation rules or debt waiver rules that potentially can create unexpected risk exposures.

Insolvency and administration:

Many expect the current climate may give rise to an increase in company liquidations and administrations of distressed businesses. Tax insurance can provide liquidators with a level of comfort in relation to a potential identified tax liability prior to releasing funds to investors/creditors.  It can also be used as a tool in the context of a pre-packaged administration, where the buyer typically has no recourse for an identified tax liability of the acquired target.

Significant, unanticipated government public spending has been essential to support business sustainability during the global pandemic, for example through furlough payments, business loans/grants and unemployment and social security payments.  Subsequently, tax authorities may be forced to adopt a more aggressive approach going forward to shore up government finances and redress national debt. If this does happen, tax liability insurance could play an increasingly important role in offering certainty for insureds in relation to managing tax risk going forward.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.