Tax Liability Insurance (TLI)
Tax insurance enables a taxpayer to either reduce or eliminate a potential financial loss relating to the tax treatment of a transaction, investment, or other activity where the legal accounting conclusions that supported such a tax treatment could be challenged by the relevant tax authority.
The policy is tailored to address the specific financial exposure of the insured should there be an unfavorable ruling: the primary amount of tax payable, any interest and insurable fines and penalties due, defense costs including the expenses involved in engaging legal or tax specialists, and gross-up amounts for taxes due on receipt of insurance proceeds.
Coverage is available for a wide range of tax risks and can be used for M&A activities or in other contexts, which we explore below.
- In preparation for a sale, a seller can address a known tax issue to ensure a smoother and more expeditious sale process
- A buyer can differentiate its bid and be more competitive in an auction situation by using TLI to resolve a known tax issue
- It can ring-fence an issue where the seller and buyer are unable to obtain a determination on a tax issue from tax authorities prior to the transaction’s close
- Can cover a tax issue that is excluded by warranty & indemnity insurance (W&I)
- Tax risk management where a tax position can be challenged by a tax authority
- Gaining certainty for the tax treatment of an entity (REIT, S corporation, partnership, etc.)
- An issue identified in a live tax audit
- Cross border and international tax issues
Tax laws are complex and with such complexity come uncertainties. An unexpected challenge to a tax structure can significantly impact the value of a company and/or the success of an M&A transaction. Tax insurance can be an effective risk transfer tool to protect those that are insured where there is an element of uncertainty regarding the tax treatment relating to a change in ownership of a company, reorganizations, or the historic tax positions taken by a company or its consolidated tax group.
Tax Insurance in South Korea
Interest in tax insurance has grown steadily over the last few years as tax authorities in the Republic of Korea (ROK) have become more aggressive to improve tax revenue, and M&A transactions, past and present, are an area of focus. ARIA continues to see new and creative applications of tax insurance to address a range of tax concerns and has advised on several successful tax policies that mitigate concerns regarding capital gains tax applicability and the identification of beneficial owners. GP-led secondary transactions can also create unique tax issues that TLI can be structured to ringfence.
Cross-border deals are a growing area of concern for buyers as tax authorities scrutinize corporations’ tax arrangements especially for those with multi-country operations. On distressed deals, tax insurance can protect the debtor and/or buyer from unexpected tax liabilities relating to a debt restructuring, cancellation of debt income, ability to use a target company’s NOLs, etc.