Tax insurance covers specific tax risks, historic or forward-looking, on deals or in the ordinary course of business. In a transactional context, it typically sits alongside a Warranty and Indemnity (W&I) policy to cover known tax positions identified in due diligence that are defensible but not free from uncertainty. For example, where a buyer and seller view a target’s tax position differently, or where the seller is unable or unwilling to give an adequate indemnity.
Outside a transaction, it protects positions a taxpayer and its advisers consider supportable but which could result in a liability if challenged. Cover is provided via an indemnity in the policy for a one-off premium, giving the insured a counterparty to call on. It can be tailored to risks and transactions of all sizes, with significant capacity available for larger, higher-value deals. It extends to the additional tax or duty, interest and penalties, the cost of defending the position and a tax gross-up on the payout. Policies typically run for seven years and can extend to ten years, often beyond the statute of limitations, so the risk doesn’t need revisiting year after year.
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Why Tax Insurance?
The practical benefits of using tax insurance include:
A known, theoretical or forward-looking tax exposure doesn’t have to sit with any one party: the insurance market takes it on instead.
The underlying tax question need not be resolved: if the position is later found to be incorrect, all (or part) of the loss is covered, giving stakeholders the confidence to proceed.
Capital that would otherwise sit tied up for years in an indemnity, an escrow account or a price adjustment mechanism while the risk plays out can instead be released.
Tax is rarely straightforward, and it’s often what stalls a negotiation. Insuring the risk takes it off the table, minimising execution risk in negotiations, and keeping momentum going, giving sellers a cleaner exit and buyers the contractual protection they require.
A seller who’s unwilling, or unable, to give a tax indemnity doesn’t have to. The insurer stands behind the risk instead, so a reluctant indemnifier is never the reason a deal falls over.
The one-off cost of a tax insurance policy represents a fraction of the potential loss in the event of a successful challenge by a tax authority, replacing open-ended exposure to an uncertain tax position.
Ring-fencing a specific tax risk protects the returns and the reputation the transaction was built on.
An insurer’s covenant beats relying on an individual, a wound-up entity, or a counterparty that simply may not have the funds by the time a claim is made, thereby reducing credit risk.
A tax risk arising outside a share or asset sale often has no natural party positioned to stand behind it the way a seller would in a deal. A tax insurance policy can fill that gap, giving the business a counterparty to call on if the position is ever challenged.
Avoids obtaining a ruling from the tax authority, a process that can take many months (often longer than a year) with no guarantee of a positive outcome, in favour of cover that can be underwritten in as little as days or weeks. A ruling process puts information in front of the tax authority that it may not otherwise have, potentially prompting audit or scrutiny down the line.
How It Works
Each tax insurance placement is underwritten on the technical merits of a specific position, supported by documentary evidence and requiring the insurer’s own confidence in the analysis.
Getting from an identified risk to bound cover typically involves the following steps:
