// tax insurance
tax insurance - a targeted solution for managing identified tax risks in transactions
tax insurance has gained significant traction in m&a and private equity transactions and corporate restructurings as a tool for mitigating identified tax risks. while warranty & indemnity (w&i) insurance generally protects buyers and sellers from unknown risks, it does not cover tax exposures that have been identified during due diligence. this is where tax insurance comes into play, offering a strategic way to transfer specific tax risks to an insurer and ensuring that such risks do not derail a deal.
tax insurance vs. w&i insurance: understanding the differences
w&i insurance primarily covers claims arising from breaches of warranties or under tax indemnities in a transaction. hence, it excludes coverage for known tax risks. in some cases, buyers can obtain limited affirmative coverage for low-risk tax matters as an enhancement to a w&i policy, but this is not always available.
tax insurance, on the other hand, is specifically designed to cover identified tax risks that have a higher degree of uncertainty. these risks may arise from ambiguous tax laws, evolving tax authority interpretations, or transactions where official clearance from the tax authorities is not feasible. unlike w&i insurance, tax insurance provides certainty over these exposures by transferring the financial risk to an insurer.
why use tax insurance?
tax insurance is particularly valuable in m&a transactions and private equity deals where neither party is willing or able to retain the risk of an identified tax issue. it allows sellers to avoid price reductions, escrows, or indemnities related to known tax exposures. for buyers, tax insurance provides protection against potential tax liabilities, enabling them to proceed with a transaction without requiring additional seller guarantees.
beyond m&a, tax insurance is also used in various other scenarios, including:
resolving uncertainties in restructurings: tax laws are often subject to interpretation, and companies undergoing reorganizations may face uncertainties regarding tax treatment. tax insurance provides assurance against adverse tax rulings.
facilitating fund liquidations: liquidators use tax insurance to distribute proceeds to investors without waiting for the expiration of the statute of limitations.
providing an alternative to tax authority clearance: in cases where obtaining a ruling from tax authorities is impractical or uncertain, tax insurance offers a quicker solution.
enabling tax-efficient exits for private equity funds: private equity investors often face uncertainty regarding tax treatment upon exit. tax insurance can mitigate the risk of retrospective tax assessments, ensuring that returns are not eroded by unforeseen tax liabilities.
securing financing for transactions: lenders are increasingly requiring tax insurance as part of the risk management framework for financing deals, particularly when tax risks could impact cash flow projections or asset valuations.
what does tax insurance cover?
a tax insurance policy typically provides coverage for:
the amount of tax due if a tax authority challenges the insured’s position
additional tax liabilities arising from adjustments
interest and penalties (where insurable by law)
legal and professional costs incurred in defending a tax dispute
a gross-up payment if the insurance proceeds themselves are taxable
policies are generally structured to match the relevant statute of limitations, often providing coverage for up to seven years. in some cases, tax insurance can also cover advance tax payments or the cost of obtaining a bank guarantee to support a tax appeal.
limitations of tax insurance
while tax insurance is a powerful risk management tool, it has certain limitations. it cannot be used to cover:
tax issues already under audit by a tax authority
cases where there is a legal obligation to disclose the tax risk
aggressive tax planning or tax avoidance schemes
risks arising from clear non-compliance with tax laws, such as failure to file required tax returns or fraudulent misstatements
conclusion
tax insurance is an increasingly important tool for businesses and dealmakers navigating complex tax environments. by transferring identified tax risks to an insurer, companies can achieve greater certainty in transactions, avoid costly disputes, and optimize deal structures. while it does not replace tax planning or compliance, it serves as a strategic safeguard that enhances deal certainty and financial stability.