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Rising demand for tax liability insurance as Australian businesses seek financial certainty

Demand for tax liability insurance in Australia is rising due to increased awareness among corporates and investment funds. Helping create value, assist in negotiations, and provides certainty for operational tax risks in M&A transactions.

By Kane Sim ,

Chief Client Officer, PEMA, Pacific

04/06/2024 · 6 minute read

More organisations are turning to tax liability insurance to ring-fence identified tax risks and gain financial protection. Although prevalent across Europe and the US, the market for tax liability insurance is still in its early days of adoption in Australia and New Zealand. Demand for tax liability insurance in this region continues to rise, with growing awareness among corporates and investment funds around the use of tax liability insurance to create value and assist commercial negotiations in merger and acquisition (M&A) transactions and deliver greater certainty for operational tax risks arising outside the M&A deal context.

Coverage and threshold for entry

Tax liability insurance typically covers the potential tax exposure, as well as interest, penalties, defence costs and tax gross-up. In short, in the event a tax or revenue authority successfully challenges the insured tax position, and this results in tax or duty being imposed, with tax liability insurance transferring that financial liability to the insurance market. Historical tax positions and expected future tax risks can be insured.

Generally, the minimum threshold for an insurer to provide cover is that a reputable tax advisor has analysed the tax position of the insured and determined that it poses a low or low-to-medium risk. This typically presents as a ‘should’ level opinion. While a degree of uncertainty is the hallmark of an appropriate risk for insurance, the insurer will need to gain sufficient comfort that the tax position is supportable and will run an underwriting process involving Marsh, the insured and the insured’s third-party tax adviser.

How long does it take to effect cover?

Depending on the complexity of the underlying tax risk, and speed and quality of information flow during the underwriting process, a tax liability insurance policy can generally be put in place within two to three weeks.

State of the market

There are currently more than 10 insurers, domestically and globally, who can underwrite tax risks in the Pacific region. This robust market has resulted in a large pool of available capacity, accommodating small and large liabilities alike, and a strong appetite across a broad array of tax risks.

Over the past few years, insurers have deepened their investment in their tax expertise, recruiting dedicated, in-house senior tax specialists to lead and perform the underwriting process. This has led to an overall uplift in the understanding of insurable risks, as well as a more streamlined process for our clients.

Cost of insurance

The insurance market for tax liability is competitive, with premium rates typically in range of 2% - 5% of the amount insured. This pricing is at an all-time low in the region. Factors that could impact premium rates include:

Complexity of the risk and associated tax law
Strength of the supporting independent opinion
Probability of risk
Jurisdictions involved.

Types of tax risks being insured

There is appetite in the market to insure all types of tax risks, including:

Loss utilisation and transfer
Withholding taxes
Capital gains tax exemptions and treaty relief
Transfer pricing
Stamp duty.

With respect to when a policy should be effected, there is flexibility around this and is typically assessed on a case-by-case basis. Marsh has placed tax liability insurance policies for clients throughout all phases of a transaction lifecycle (pre-signing, during the hold period, and on exit). We have also placed numerous tax risks for corporate clients that are unrelated to an M&A transaction.

Using tax liability insurance in M&A

Tax liability insurance was originally developed to help parties within an M&A transaction de-risk known issues not typically covered by a warranty and indemnity (W&I) insurance policy. Tax liability insurance helps sellers achieve a ‘clean exit’ and provides buyers with appropriate deal protection.

There are several ways that tax liability insurance can be used to help facilitate efficient M&A, for example:

Different views of the risk: Buyers and sellers involved in a transaction may have different views regarding the uncertainty of a particular tax position and/or quantum of the identified exposure. Instead of purchase price adjustments, specific indemnities or escrow, which often are not palatable to the seller, tax liability insurance can instead be used to transfer the risk away from the deal parties to the insurance market.
Auction process: Tax liability insurance may be beneficial in highly competitive transactions with multiple bidders. This coverage can give a competitive edge to a bidder by empowering them with the confidence to put forward their most attractive offer, while protecting themselves from assuming an unintended tax exposure.
Reorganisation related to a transaction: Sellers often undertake a pre-completion restructure in order to achieve a more commercially viable structure. This may involve a transfer of assets, a management rollover or other changes that often create tax risk. Tax liability insurance can be used where neither the seller nor buyer are prepared to absorb the potential exposure.
Treatment of sale proceeds: There is commonly uncertainty as to how proceeds a seller receives from an exit should be taxed (e.g. revenue gain, capital gains tax, or applicable exemption). Tax liability insurance can protect the seller’s position and enable them to repatriate or redistribute the sale proceeds without setting aside funds for the potential tax liability.

Using tax liability insurance outside of M&A

Outside of the M&A context, tax liability insurance can also be utilised to address operational tax risks, for example:

Group reorganisation: Reorganising a business may give rise to various tax risks, including capital gains and stamp duty. Tax liability insurance allows companies to transfer the risk to the insurance market and reduce uncertainty.
Balance sheet protection: By keeping tax risks off the balance sheet, tax liability insurance provides companies with the option of using cash otherwise locked up as reserves. Equally, it can be used to give companies comfort on their deferred tax assets (e.g. from accumulated losses).

Whether it’s being used as part of an M&A transaction or to address an ongoing business risk, tax liability insurance can be a powerful tool to create value and reduce uncertainty related to an organisation’s tax risks.

For more information on how Marsh’s team of specialists can help you assess whether tax liability insurance is the right tool for your business and how it can be tailored for your unique needs, contact your Marsh representative.

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