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In complex sales and transactions, there can be many uncertainties, and there may be losses that were not originally anticipated when the transaction was agreed.
Tax deeds and warranties exist to provide an element of protection against unexpected liabilities and losses.
The documents drawn up to set out tax deeds and warranties can often be long and full of technical financial jargon. This can make them difficult to understand if you are not already familiar with the concept.
This guide runs through how tax deeds and tax warranties work and the key points you need to know about each.
What Are Tax Deeds And Warranties?
Both tax deeds and tax warranties are used in many different types of share purchase agreements; they have similar but not identical purposes.
A tax deed is used when a buyer is taking responsibility of a company after the purchase of shares. It provides protection against any tax liability that arose before they officially took ownership of the company.
A tax warranty is a type of document which warrants that everything within the business is exactly how the seller sets out. Tax warranties are often covered by the disclosure letter and any areas of risk are highlighted.
The result of these covenants is that the seller must agree to pay for all liabilities which arose before the transfer of ownership on a pound for pound basis.
We are now going to look at these two types of documents in more detail.
Although the aim of the tax deed is simple, the execution can be particularly difficult to follow as they may extend to 20-30 pages long, accompanying the share and purchase agreement.
When someone takes over a company, they automatically become responsible for the tax liabilities of the company moving forward. It is possible that tax liabilities may arise which relate to a period before the new owner assumed responsibility; a tax deed provides protection from this extra liability.
It does this by creating an agreement from the seller to pay for any unaccounted for tax liabilities which arise at a later date. The specification of “unaccounted” tax liabilities is an important one; a tax deed will not cover any tax liabilities which arise but were previously known about. These should have been included in the purchase calculations and negotiations.
This deed covers the liabilities on a pound for pound basis and the buyer does not have to prove fault.
Another situation a tax deed protects against is the possibility of claims being made against the company by HMRC. Where this relates to the pre-sale period, the tax deed provides the buyer with the right to make a claim.
It is usual for the possibility of an HMRC claim to be set out in the tax deed, including the rights the seller would have to be involved in communication. Although the buyer would normally be the one to lead communication with HMRC, sellers and their accountants would expect to have an opportunity to conduct investigations and to contribute to a response.
Tax warranties are used in similar circumstances and complement tax deeds. There is a big overlap between both, but it is useful to have both a tax warranty and a tax deed.
Where the tax deed seeks to provide a means of compensation, a tax warranty’s purpose is to provide information and assurance.
Warranties are a type of statement that the seller provides giving details of the tax position and any fines or penalties that they have knowledge of. This includes past details as well as any arising that the seller has knowledge of.
Providing the seller provides accurate information in the tax warranty, there can be no action for breach of warranty at a future date.
Information that is normally found in a tax warranty includes:
- Tax disputes
- Tax compliance
- Overseas and residence issues
- Tax relating to employees
- Tax planning
- Group matters (where relevant)
The tax warranty should allow the buyer to calculate a fair and accurate price, and also allow them to make a balanced decision about whether to proceed with the purchase.
In theory, a tax warranty would also provide a buyer with an avenue for future redress if the seller was found to be in breach. The buyer can claim damages if the information contained in the tax warranty is not correct. The limitations to the tax warranty can be negotiated during the sale e.g. time periods and thresholds. The damages the buyer can claim are equivalent to the losses that they have suffered. However, the buyer will have to be able to prove their losses and has a duty to mitigate these.
In reality, the tax deed provides better protection since a tax warranty is primarily to compel the seller to mitigate any losses and disclose the position in full.
A tax warranty still applies even if the seller believes they are providing accurate information at the time of the sale. If they rely on information from a third party, such as an accountant which proves to be incorrect, they are still liable under the terms of the tax warranty.
Limitations Of Liability
There are some exclusions and limitations which apply to both tax deeds and tax warranties, which are designed to be fair to both parties.
There is usually a financial limit and a time limit requested by the seller, which can be negotiated by the buyer to reach an acceptable figure.
The seller should also not be liable for anything which was priced into the sale. It is the buyer’s responsibility to check how the calculation was made and what factors have been taken into consideration to reach the sum.
If the buyer brings about a liability by acting in any way which is different to the normal course of business, no claim can be made. Exclusions typically cover voluntary acts which produce a liability for the seller that should or could have been avoided.
There may be other specific exclusions in the warranty and deed, so it is imperative that both are scrutinised carefully before completion.