Five years ago, I can comfortably say that almost no standard deals would have incorporated a standalone tax liability policy into the cover for the deal, while currently at least 10% of transactions will consider tax liability cover on an M&A transaction.  Awareness of what tax liability insurance can provide has been growing for a number of years which has expanded the use of the product in M&A deals, as well as wholly internal reorganizations or restructurings.

Tax liability insurance is one of the newer tools in the M&A advisor’s toolbox.  One area we see increased interest is on cross-border deals, where both buyers and sellers are subject to their own separate home taxation regimes and where there may also be tax consequences or effects in other international jurisdictions where one of the operating companies involved is located and taxed.

Often the impetus for using tax liability insurance is a surprising one.  While many might consider that tax liability cover is applicable only where there is a large inherent risk, it can also be used where a deal can be structured in different ways, giving rise to two or more possible outcomes from a tax perspective which differ slightly.  One or more of the counterparties in the transaction may have a preference for one particular tax structure, even if it has somewhat greater uncertainty around it.  In that scenario, tax liability insurance transfer all or a portion of that risk or uncertainty away from the deal, helping all parties get comfortable, without adding to the likelihood of a taxation event.

In this context, the tax liability cover can function similar to a representations and warranties policy, helping take the sting out of a potential standoff and offering an amicable resolution on a reasonably quick time table.

In addition, there may be situations in which a remote but material tax risk is identified within a transaction, and here the cover can help to prevent ‘buyer/seller fear’ from halting progress in a transaction. It is also worth noting that the involvement of private equity investors can sometimes result in novel transaction structures; and such parties also tend to be more innovative with tax planning than a founder owned business for example.  In these cases, the counterparty may have increased sensitivity to tax matters and will consider tax liability cover to actively protect themselves.

Alongside the increase in the use of standalone tax liability insurances, we have seen a parallel increase in the issue of hybrid Representations & Warranties (R&W) and tax policies for certain entity or business types.  These are common to certain structures which may have inherent tax compliance ‘headaches’ in spite of other advantages and, in some cases, a standard R&W policy might not cover the full suite of tax issues that could arise.

One of the most commonly seen uses of tax liability policies currently are certain types of tax credits – particularly energy tax credits, locking the value of these into a deal even where the credit has not yet been issued.

REITs (Real Estate Investment Trusts) are another corporate vehicle which has a favourable tax treatment built into its structure.  The US government moved to encourage a growth in real estate investment and development and, as a result, incentivised corporation tax levels for REITs.  However, these come with the trade-off of increased compliance considerations and in the case of a REIT being sold, the new owner may have concerns about inheriting liability for retrospective taxation being levied on pre-closing tax periods.  Traditionally in this situation, the transacting parties have used R&W products, even though the cover given may be incomplete for certain tax liabilities. R&W insurance is also not designed to cover tax issues that arise from the deal itself.  These examples highlight how Tax liability insurance, in some instances married to a R&W policy, can solve some of these concerns and is contributing to the increasing popularity.

For all sides, tax liability insurance is an increasingly useful – and increasingly used – tool, and it can help smooth the path of certain types of deals in a way that a standard R&W policy cannot do alone, in addition to many of its standalone benefits outside of a deal setting.