Issues relating to taxation are the biggest cause of Warranty and Indemnity (W&I) claims in the UK, according to latest research from insurance broking and risk consulting firm Aon. The firm analysed the W&I deals underwritten between 1990 to 2002, a period of high levels of M&A activity in the UK, and found almost a fifth (17%) of warranty claims brought against the seller in 1999 were a direct result of taxation liability. This figure more than tripled to 66% in 2002 and Aon predicts taxation liability is of growing significance for UK businesses.
The most typical taxation liabilities range from VAT to corporation tax or PAYE issues. A seller is usually required by a buyer to provide an indemnity against the liability that relates to their period of ownership (i.e. before the sale.) In doing so, the seller draws a line in the sand in terms of where the responsibility for tax liability lies. Thereafter, once liability is uncovered, it very much depends which period the tax liability related to in determining where the responsibility lies and which party bears the cost. The seller can then insure their liability under this indemnity by taking out a standard W&I insurance policy, to cover these unknown or unidentified risks at the time of sale.
Aon’s research also reviews deals underwritten in 2003 and 2004. However, due to the sharp decline in M&A activity during these two years, the subsequent decrease in the number of claims over these two years is not representative of the overall trend.
Neil Cooke, partner at law firm Barlow Lyde & Gilbert, said: “We have witnessed an increasing volume of UK claims under the tax warranties and the tax covenant, across a broad spectrum of transactions, over the past seven years. We have also seen a marked increase in the size of the claims being pursued. It is difficult to identify any common causes or trends in terms of why and how the claims arise which emphasises the potential importance of insuring against the wide variety of tax liabilities that might materialize.”
Examples of the type of taxation liability an insurance policy can cover include: a lawful business restructuring which is carried out for commercial purposes and should result in a tax neutral position; potential tax risks relating to a past acquisition, which the buyer is unwilling to take; and instances where the seller is unwilling to address the buyer’s primary concern: failure to provide an indemnity. However, taxation insurance would not cover a future change in law or tax avoidance schemes.