Corporate Deal Basics: The Tax Covenant

A well-advised buyer of a company or group of companies will often require a tax covenant, often referred to as a tax deed.  The tax covenant is a way of adjusting the purchase price for the shares being acquired by reference to tax liabilities of the target company or group.

The buyer will also usually require detailed tax warranties in the share purchase agreement.

Sellers might find it curious that a buyer wants tax warranties and a tax covenant for the same deal.  However, this is not merely belt and braces.  Tax is different to other risk areas (apart from the fact it is inherently complicated!) for several reasons, including that:

1.         There are conceptual difficulties in quantifying losses for breach of tax warranties;

2.         Buyers usually do not want their awareness of tax problems to inhibit recovery in respect of them.  Accordingly, disclosure usually has no place in a tax covenant; and

3.         The target can have secondary liabilities which arise after completion, which might not be captured by warranties alone.

The tax covenant is drafted in a very powerful way.  That means sellers of shares should get professional advice to ensure that it does not work unfairly against them.

Tax covenants are an active area. There have been recently reported cases where parties have gone to court to resolve differing opinions of the effect of the tax covenants in particular deals.

If you have any questions about tax covenants or the tax aspects of corporate transactions, please contact Nasim Sharf on 01482 337336 or email nasim.sharf@rollits.com

Posted on: 01/03/2013

This article is for general guidance only. It provides useful information in a concise form. Action should not be taken without obtaining specific legal advice.

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