Tax indemnity insurance helps to secure sales proceeds upfront

    Tax indemnity insurance continues to be of interest for our accountancy clients and corporate finance teams. Typically, most activity has centred on mergers and acquisitions and the tax issues identified during the due diligence process by advisors to the purchasers. Where a specific tax risk has not been identified by the purchaser’s advisors, warranty and indemnity insurance is often required as a general indemnity against unspecified risk to include tax. However, we have seen two potential sales during November, where specific tax issues had been identified by the vendors themselves as potential obstacles to sale. Where the vendor has anticipated the potential issue, it can be of significant benefit to arrange tax indemnity insurance in the early stage of sale negotiations, rather than rely on a general tax warranty, as the following examples demonstrate.

    One case involved a potential tax risk around an employee reward scheme which had granted conditional entitlements to key employees. Due to the nature of the tax issue, advisors of the vendor were unable to obtain any sort of clearance or reassurance from HMRC.

    The options therefore were to place part of the agreed sale proceeds in Escrow or to secure tax indemnity insurance to remove concerns over the inherent tax risk and allow the company sale to go ahead, enabling the vendor to receive the full sale proceeds at the time of the transaction. Whereas, general warranties and indemnities insurance premiums are often set at 3% or less of the indemnity sought, the industry average for premiums on tax risks are higher, with the average premium sitting at 7-8% of risk.  

    A tax indemnities policy will normally run for a period agreed between insurers and insured. In direct tax cases this is invariably based around the time limits HMRC has to make discovery assessments, which is likely to significantly extend the time between the transaction being agreed and the final proceeds being paid over to the vendor.

    Whilst a tax indemnity premium on a risk of £1m may cost £80,000 plus Insurance Premium Tax (currently 12%), the purchaser will be prepared to release £1m sale proceeds upfront, enabling the vendor to have use of all the proceeds earlier than would be the case without a policy in place. In practice, this works well, when there is uncertainty over the value of future tax claims that might affect the purchaser’s planning and forecasts. One sale we have seen, involved concern over the availability of tax allowances, which were unclaimed at the point of sale and which had been identified in the sale documents.

    The figures below are for illustration only:
     Accounting period  2014  2015  2016  2017
     Tax on allowances  £250,000  £250,000  £250,000  £250,000

    The sale contract specified that the agreed proceeds would include a retention period for the tax risk, with the contingent proceeds only to be released after a four year period, following the end of the enquiry window of the latest tax return submitted before the sale. As a result, the release of the sale proceeds for 2014 would not have materialised until 2020; i.e. the normal time limit for the submission of the 2014 return would have been in 2015 with the enquiry window therefore closing in 2016. Taking into account HMRC’s four-year time limit for discovery, the retention of funds for the 2014 accounting period would need to continue until 2020. If the illustration above is then followed through, the final retention period would end in 2023.

    By securing a tax indemnity policy in 2017, the full £1m of sale proceeds are received immediately upon the sale being finalised, rather than amounts being released over the next six years until 2023,when the last retention period would expire.  

    Where clients are considering a sale within the foreseeable future and there is a known potential tax risk which could frustrate the sale, tax indemnity insurance could well be the answer. It facilitates the sale quickly and with the minimum of fuss; thereby, enabling all the parties to focus their efforts on the future.

    For further information and help with tax indemnity insurance please contact Abbey Tax on 0345 223 2727 and ask for Jeremy Leach.