Managing tax risks in M&A
February 2024 | TALKINGPOINT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
February 2024 Issue
FW discusses tax risk management in M&A with Hugo Webb and Peter Griesch at Ambridge.
FW: Could you explain the purpose of tax insurance? In what contexts is it typically used?
Webb: Tax insurance is most often used to provide cover for the tax treatment of a particular transaction. For example, it can protect against a tax authority applying a different statutory interpretation to the transaction than that adopted by the taxpayer – a legal interpretation risk – or the tax authority interpreting the facts relevant to the transaction in a different way from the taxpayer’s interpretation – a facts and circumstances risk. Tax insurance essentially provides certainty to a taxpayer that the tax treatment it has adopted for a transaction will ultimately be respected. If there is a successful challenge to this tax treatment, the tax insurance policy would compensate the taxpayer for the tax-related losses it has incurred. It is possible to also provide cover for a broad range of tax risks in a variety of commercial contexts, including as a replacement or enhancement to an indemnity for an identified tax risk in a transaction, or cover for a standalone tax matter outside of a transaction. Insurers will always want to understand the business reasons behind why the tax position is, or has been, taken, and why the insurance is being sought.
FW: In the M&A context, what benefits can tax insurance provide to the buyer and to the seller? How can it assist an auction process?
Webb: Tax insurance policies can be particularly beneficial in a transaction context. They can allow buyers to enhance their bids by not requiring an escrow or indemnification or taking purchase price reductions for identified tax issues; rather, they could just reduce the price for the premium cost of obtaining a tax insurance policy. Alternatively, the seller can offer a tax insurance policy in lieu of the aforementioned other risk allocation mechanisms. As such, tax insurance policies can allow sellers to make clean exits and auction buyers to further differentiate their bids, while receiving the protection they desire. In some instances, tax insurance is the tool that facilitates a transaction that might otherwise crater over the identified tax issue. For example, an identified issue could create such a large downside exposure that unless insurance is procured the deal cannot progress, because the tax loss, if it were to occur, would destroy the economics for the buyer.
“Because of the dynamic nature of M&A negotiations, including regulatory requirements and financing terms, tax risk submission support will vary.”
FW: Could you provide some examples of insurable M&A-related risks?
Webb: There are a large range of matters that can be covered by tax insurance policies, and these include whether pre-completion reorganisations are taxable, whether debt restructurings or debt equity swaps give risk to taxable cancellation of debt income or whether demergers meet the conditions for tax-free treatment. Save for no aggressive tax planning or abusive tax risks, there are no hard and fast rules as to what is and is not insurable; however, insurable cases would be at a ‘should’ or ‘more likely than not’ level of confidence. The motivations for seeking tax insurance include circumstances where there is no clear precedent or guidance, where it is not possible to obtain a clearance or a ruling from the relevant tax authority within the required timeframe, where there is very significant downside exposure or where there is little margin for error in the financial modelling of an investment.
FW: For sellers involved in an ongoing audit or litigation, to what extent are the related risks insurable as a means to avoid a large escrow? How are such policies structured, and how do they differ from policies that cover issues not connected to an active audit or litigation?
Griesch: We see these audit or litigation types of submissions from brokers with some regularity. The tax insurance product is of particular value in this context, as it is sometimes the only path forward for buyers. Because buyers are not the taxpayer, they may only be aware of the audit or litigation at a very high level. Sellers will often be reticent to share significant information about an active audit or litigation for fear of waiving legal privilege, or sharing confidential information with another party should the deal fall through. Engaging an insurer not only relieves a buyer of a potentially significant tax burden, but also often allows them to peek behind the curtain in ways they may not have been able to without purchasing insurance. This can often give a buyer better insight into the overall processes of a target. Generally, the policies are largely structured the same as non-contingent tax policies or policies not covering tax liabilities of successor purchasers, but special consideration will be given to ensuring that the transactional documents adequately cover tax information sharing and cooperation going forward. As a general matter, all tax policies are contingent policies in the sense that they require final adjudication of the covered tax positions.
FW: Are there any particular factors that insurers look for when considering a tax risk? What factors automatically put a tax risk outside an insurer’s risk appetite?
Griesch: Risks that are adequately supported with both factual documentation and legal advice at a high level of comfort are the most attractive. Because of the dynamic nature of M&A negotiations, including regulatory requirements and financing terms, tax risk submission support will vary. Experienced tax counsels are adept at identifying a good risk, a risk with good potential upon further support and risks that fall outside of their appetite. In conducting a review, several factors are weighed. First, whether the covered tax position is supported by written advice from counsel. If there is written advice from counsel, is it in the form of a covered opinion, a memorandum or email? Second, whether the confidence level of the conclusions appears reasonable and in line with prevailing authority. Third, whether counsel is available for and responsive to follow-up questions and requests. Fourth, if the advice is at a lower confidence level, why is that? Is the question novel, or is the taxpayer taking an aggressive tax position? Fifth, whether the insurer has seen the planning strategy before, and if so, does it appear to be a new and aggressive strategy recurring in the market? Very few things are completely off-limits. However, insurers will not consider tax avoidance risks or strategies, or tax planning that takes ‘creative licence’ with interpreting the law.
“In some instances, tax insurance is the tool that facilitates a transaction that might otherwise crater over the identified tax issue.”
FW: Could you provide an overview of the underwriting process for M&A tax issues?
Webb: The first stage of the underwriting process is that a broker submission is provided for the relevant risk. An insurer would expect to receive a summary of the risk, the advice received on the risk and exact details of the coverage required. Once this information is provided, the insurer can then usually confirm whether the risk is within its appetite or not and provide a non-binding indication of what the pricing will be in fairly quick order. If the terms are selected, the insurer would then enter into underwriting. This would involve sharing information and documentation requests with the proposed insured and possibly having a written or telephone Q&A session to carry out underwriting due diligence. The preparation and negotiation of the policy can be carried out in tandem with, or following completion of, underwriting due diligence. The policy will contain a definition of the tax treatment that is to be insured, together with the insured providing representations as to facts that have not been, or are not capable of being, evidenced by contemporaneous documentation.
FW: Once a policy has been issued, how are active audits and litigation matters typically handled?
Griesch: Generally, whether the covered tax position is an actively audited or litigated matter, or a tax position an insured intends to report, the procedures are the same. There is an expectation that an insured communicates regularly and openly with the insurer about tax authority contact, conversations and plans to handle the matter with counsel. It is common that counsel for the insured be named in the policy as acceptable counsel, but that is not a policy requirement. Nor is an insured locked into that counsel should it be agreed – by the insured and the insurer – that other counsel is better suited for the matter. Insurers will require association in the matter, but in no way will they seek to interfere with the insured’s or insured’s counsel’s reasonable decision making. Insured and insurer are expected to work in concert for the best results.
FW: For M&A covered tax positions, how important is it to have underwriters experienced in both transactional and controversy practice, as well as the underwriting process?
Griesch: It is invaluable to have experienced underwriters. Lacking one or the other can make the experience unnecessarily painful for the insured, broker and counsel. It is equally important to understand tax technical details as it is to understand whether a position is likely to alert a tax authority, how such authority would likely receive such position, ways to mitigate such risk and how to structure a policy in order to move forward in such a way that the insured receives meaningful coverage. Insurers are thoughtfully protected. An underwriter without both transactional and controversy experience is likely to walk into a position they do not fully comprehend, or unwittingly walk away from an attractive risk without having a creative path forward.
Hugo Webb has been a leading underwriter at Ambridge since 2015 and is head of international tax and contingency insurance at Ambridge. Prior to that he worked in private practice as a tax lawyer at Akin Gump, Bingham McCutchen and Olswang. He can be contacted on +44 (0)20 3874 0055 or by email: hugo.webb@ambridge-group.com.
Peter Griesch is a managing director and head of US tax and contingency insurance at Ambridge. Prior to joining Ambridge, he worked as a senior vice president, head of tax and contingent underwriting, at Berkley Transactional. He can be contacted on +1 (202) 510 1868 or by email: peter.griesch@ambridge-group.com.
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