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Tax Insurance: Protecting Your Tax Losses

Guidance on how tax insurance can help companies protect their tax losses in order to secure future tax savings.

02/03/2021 · 3 minute read

In the normal course of business, many companies would incur tax losses — for example during periods of capital expenditure or trading difficulties.  This is probably even more relevant now, considering the difficult trading conditions many companies faced during the COVID-19 pandemic.  Tax losses may be carried forward over subsequent years and offset against future profits of the company.  As such, tax losses can be an asset in the company’s hands.

Clearly, such tax assets can be valuable, and very often corporate or private equity buyers (“Buyer”) of companies with significant tax losses, would pay for the value of these losses.  However, there are two main risks in relation to tax losses in the context of M&A transactions:

  1. The validity of the tax losses.
  2. The forfeiture of tax losses post acquisition.

This bulletin provides guidance on how tax insurance can help companies protect their tax losses in order to secure future tax savings.

The validity of tax losses

One of the main concerns of a Buyer when purchasing an entity which purports to have significant tax losses is whether these tax losses are actually valid and recognised as such by the relevant tax authority. Clearly, if this is not the case, significant tax costs may arise since profits cannot then be sheltered from tax by offsetting such losses. 

Provided the insurer can substantially verify the existence of the tax losses, the risk that the relevant tax authority would not accept the tax losses may be insurable. In this regard, initial views on insurability will be determined from a review of due diligence performed by a reputable third party tax advisor in relation to the validity of the tax losses, which would then be confirmed by the insurer during the underwriting process.

The forfeiture of tax losses post acquisition

In certain cases and in certain tax jurisdictions, the mere change of control of a company may result in the forfeiture of tax losses. This is obviously something, which should be on the radar screen of any Buyer.

For example, in an M&A scenario, tax losses can be forfeited:

  1. On the transfer of a certain threshold percentage of shares in a company, subject to certain conditions.
  2. On the trigger of certain tax anti-avoidance provisions, e.g. if a tax authority is of the view that a transaction was done mainly in order to benefit from the tax losses;.
  3. On a subsequent change of the nature of the trade performed by the relevant entity, something which may be considered by the new owner post acquisition for various reasons.

Because the application of these rules may be dependent on the facts of each case and subject to various conditions, uncertainties as to the application of the relevant laws may exist.  This can give rise to significant tax risks relating to the potential forfeiture of tax losses.

It is already well-established practice for tax insurers to provide insurance cover for such risks, provided the tax position is supported by a strong tax analysis performed by a reputable third party tax advisor.

Conclusion

The tax insurance product has evolved tremendously over the past number of years, and has become an effective tool to manage tax risks and unexpected financial exposures relating to the validity of tax losses allowing Buyers to “lock-in” value . In our experience, such risks can comprehensively be insured at competitive rates, and it is only logical that a tax insurance solution should be considered when seeking certainty of future availability of tax losses.

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