Tax reporting for corporate acquisitions and other business transactions can be enormously complex. Unique facts and circumstances of a transaction often don’t fit squarely within existing guidance, and the tax that hangs in the balance may be substantial.
Tax opinions from outside advisors quantify risk, but do not protect the taxpayer from financial harm if the underlying tax position is successfully challenged by a taxing authority. By contrast, private letter rulings even where available, provide certainty as to a particular tax position but require substantial time to obtain, potentially stressing a transaction’s timeline.
Intelligent Strategy
Tax insurance provides financial protection for a specific insured tax position, indemnifying the insured against additional taxes, interest, penalties, and defense costs that result from a challenge of the tax position by a taxing authority. Tax coverage can often be obtained for a single upfront premium payment of 2%-5% of the policy limit ($20k to $50k per million of coverage), but may be higher for more complicated risks or for tax positions under audit.
These policies have been used by top private equity funds and Fortune 500 companies to effectively manage contingent liabilities for federal, state, local, and foreign taxes. There are currently more than a dozen highly-rated insurers in the US market that have specialist teams underwriting these complicated risks, representing an aggregate market capacity of more than $1 billion in policy limits for a given tax risk.
Benefits of Tax Insurance
- Structure protection against contingent liabilities for taxes that could be catastrophic to the taxpayer’s business or could threaten the completion of a potential M&A transaction
- As a buyer, obviate the need for (or reduce the cap on) seller indemnities, easing contract negotiations and providing deal security
- As a seller, backstop an indemnity obligation for a specific tax issue that the seller was required to give
- Obtain effective certainty as to an intended tax result without approaching the IRS or other taxing authority
- Access high credit quality of third-party insurers rather than uncertain credit quality of a counterparty
- Neutralize financial statement impact of related Fin 48 reserves
Three Contexts Where Insurance Helps
Private Equity and M&A Acquisitions
Tax insurance can be utilized to cover specific tax risks that are identified during the buyer’s tax due diligence or to effectively guarantee the intended tax treatment of the acquisition itself. In an M&A context, it transfers a potential tax liability to a third-party insurer — clarifying the target’s valuation, easing negotiations and providing greater deal certainty.
Historic Tax Risks
Taxpayers can use tax insurance to manage historic tax risks in their businesses, providing certainty as to the tax impact of historic transactions and insulating the company from the financial harm that would result from a successful challenge by a taxing authority. Depending on the circumstances, a policy may also provide a financial statement benefit if the coverage allows the taxpayer to release (or to not post) a related Fin 48 reserve. Tax insurance may even be obtained after the initiation of an audit of the insured tax position, though at a greater premium costs.
Commonly insured tax positions:
- Tax-free qualification of Section 355 spin-offs, and Section 368 tax-free reorganizations (mergers, asset acquisitions, etc.) in connection with internal restructurings or acquisitions
- Tax status of S-corporations, REITs and other entities
- Valuations underpinning the reporting of a taxable transaction
- State and local tax matters
- Application of FIRPTA, transfer, withholding or similar taxes
- Issues relating to executive compensation and employment arrangements
- Foreign tax credit utilization and other international tax issues
- Net operating loss issues, including section 382 limitations
Facilitating Tax Equity Investment
Tax policies can be utilized to cover various aspects of tax credit qualification in connection with investments in solar, wind and other credit-eligible projects. These policies give tax equity investors greater confidence that the expected tax credits (or their economic value) will be realized notwithstanding a challenge by the IRS or other taxing authority. The result is that insurance eases credit concerns about developer indemnities and helps to attract tax equity investment.
Commonly insured tax credit positions:
- Calculation of qualified basis amount for solar projects claiming eligibility for the Investment Tax Credit (ITC)
- Risk of recapture of the ITC
- “Begun construction,” “continuous efforts” and “re-power” qualifications in wind projects claiming the production tax credit
- Rehabilitation tax credit, low-income housing tax credit, and other federal and state tax credit issues
- Investment holding structure and tax allocations will be respected for tax purposes
Partner with our M&A specialists to navigate complex transactions with confidence. Ensure your deals are secure and successful.