Navigate the risk
Tax liability insurance offers an insurance solution to mitigate or remove uncertainty in respect of a challenge to a tax treatment by a tax authority. Tax liability insurance can be secured before, at the time of or after a given transaction.
Sellers are increasingly using the product ahead of a transaction to take a negotiating point off the table – avoiding a price chip.
Tax liability insurance provides financial cover to the insured following the crystallization of an insured tax liability and can include interest and penalties (save that this will not include interest and penalties that may be incurred with respect to any “reportable transaction” as per Treasury Regulation section 1.6011-4(b)).
When it is used
Tax liability insurance can be used in many ways to cover local, state and federal tax liabilities. The policy offers a useful solution when:
- Buyers and sellers cannot agree to allocate identified tax risks between themselves
- It is not clear what line a tax authority will take on a given tax treatment or how a court would interpret a given tax law
- The likelihood of a liability crystalizing is low but the quantum is too high to comfortably account for
- There is a strong defense file in respect of a tax treatment but there is a risk none-the-less
Tax liability insurance can be used to:
Take an identified risk off the deal table
Increasing the indemnity cap through insurance whilst simultaneously reducing the indemnity cap for a seller
Negating the concerns about the creditworthiness of a seller using an A-rated insurer as a counterparty
Allow for a clean exit meaning the seller can distribute proceeds of a sale and liquidate immediately from closing, boosting IRR
Obtain more protection than a seller is willing to give
Transfer a contingent liability from your balance sheet to that of an insurer
Provides financial cover to the insured in the event of a crystallization of an insured tax liability including, where possible, defense costs, interests and penalties.
A Tax Liability Policy will be held by the company facing the specific tax liability in question or, where relevant, the buyer or seller under a purchase agreement.
The policy period will seek to match the statute of limitations in the relevant jurisdiction. This is typically up to six years.
Retention or excess
This is typically a nominal amount or nil. In certain circumstances, this will be used to prevent recovery for a certain amount of defense costs.
The estimate amount of the tax liability plus interest, penalties and defense costs.
This is calculated on a case-by-case basis and can range between 3 – 10% of the policy limit. Factors affecting the premium include the likelihood of the liability crystalizing, the activity of the tax authority in question, the robustness of the technical defense available and the complexity of the liability.