The rise of tax liability insurance

The use of tax liability insurance
(TLI) has grown substantially over the last five years across the globe. This
growth has been in conjunction with, and largely because of, the growth in the
use of warranty and indemnity insurance (W&I) by the private equity community
on portfolio acquisitions.

The majority of TLI policies emanate
from acquisitions of businesses and real estate (in this context, real estate
includes infrastructure and renewables assets) where a potential liability
relating to the tax affairs of the target or the structuring of the transaction
is identified by the buyer’s due diligence, or where there is a potential risk already
identified by the seller. On the basis that such a risk is identified before
closing, it would generally be excluded from cover afforded by a W&I policy,
as these are intended to insure against ‘unknown risks’ covered by the
warranties and tax indemnity in the acquisition agreement.

The number of W&I policies written
by the global mergers and acquisitions (M&A) insurance market has increased
approximately 20% year on year for the last decade. Based on information from
insurers, there were over 6000 policies placed in 2019 globally. There were more
than 500 tax enquiries sent to the tax insurance market in 2019, and despite
the impact of COVID-19, June 2020 was one of the busiest months in terms of tax

Such a significant increase in
the use of tax insurance policies has resulted in an equally significant
increase in dedicated tax expertise to the insurance market to service such
demand. At the time of writing, there are more than 20 teams in Europe alone
able to provide TLI policies, up from approximately five in 2015. The impact of
such rapid growth has led to increased competition between insurers with new
teams continuing to join the market. This means not only lower premiums, but
also a broadening of the insurer’s appetite as to the category of risk and the
jurisdiction in which it arises that they will consider.

What risks are typically insured?

Although TLI, along with M&A
insurance more generally, is sector agnostic – a significant proportion of the
risks seen in the European market are related to real estate transactions. The
rationale for this is that similar types of risks based on similar fact
patterns tend to arise frequently on real estate transactions, and as Richard
Taylor-Whiteway of Brockwell Capital notes, “real estate investment structures
are essentially a series of cashflows and are heavily model-driven, which means
that any tax leakage will have an adverse impact investment returns”.

Real estate TLI examples in the
UK include:

  • Tax residence of
    offshore property companies;
  • Application of transactions
    in land rules; and
  • VAT related to the
    sale of a property as the ‘transfer as a going concern’.

This is not unique to the UK.
Each country across Europe has its own examples that arise frequently, such as the
civil law activity tax (CLAT) in Poland, 3% tax in France or the real estate transfer
tax (RETT) in Germany, which all have been frequently insured. In the US,
insuring the availability of tax credits across various sectors and affirmation
of real estate investment trust status is also common. Insured risks emanating
from real estate transactions have accounted for as much of 50% of the policies
placed in recent years, which has since dropped to approximately 30%. This is
on the basis that as the number of tax insurers has grown, they have had to expand
their appetite to include a broader range of risks and dynamics due to competition
for the more frequently insured.

Impact of COVID-19

Despite the continued use of TLI
policies in M&A, there is a general acceptance that the proportion of
non-M&A related policies is going to increase significantly over the coming
years. The pace of this evolution will undoubtedly increase due to the market
shock caused by COVID-19.

There has been a recent shift in
focus by the M&A insurance market to servicing ‘distressed’ arrangements,
for example, where businesses look to conduct reorganisations to simplify group
structures, rationalise underperforming assets, or make changes that are
required as part of a re-financing, and subsequently tax risks in some form may

Insuring tax risks emanating from
restructurings is not new to the M&A insurance market, but nonetheless the
number of policies arising as a result is likely to increase in the short to medium
term. Increases in the level of scrutiny of tax authorities
and a bigger focus on tax compliance also has a direct impact on the number of
policies being placed.

Andrzej Pośniak, managing partner and head of tax at CMS in Poland,
notes that “currently, Polish tax regulations list a considerable number of
issues that cannot be covered by tax rulings. As a result, many businesses are
turning to TLI to address risks that cannot be addressed by engaging with the
tax authorities”. 

Equally, the stress that COVID-19
restrictions are placing on the cash flows of many businesses has caused those
with monies locked up in escrow or deferred payment arrangements related to tax
to turn to TLI as a means to unlock trapped cash.

“It is common for many reasons,
be it an M&A transaction, financing arrangements, real estate development
or otherwise, for amounts of money flowing between businesses to be deferred or
held in escrow pending the resolution of a tax issue. Lately, there has been
significant demand from clients to obtain the early release of such trapped
cash, and TLI has proved an excellent solution for replacing the downside
protection of an escrow or deferred payment arrangement. It allows cash to be released
while maintaining financial protection for the tax issue” commented Ben Jones, partner
and head of London tax at global law firm Eversheds Sutherland.

Moreover, as tax authorities deal
with the administrative burden of government responses to COVID-19, the time
required to obtain a ruling or clearance has increased and taxpayers are
increasingly using TLI as an alternative. “Requests for cover during recent
months,” notes Taylor-Whiteway, “have frequently related to where tax insurance
is being used instead of approaching a tax authority. We can respond in a
matter of days and have a policy in place within a week. The speed of insurance
can be key to getting a deal done.”

Staffan Bos of Transact Risk Partners
notes that “even jurisdictions like the Netherlands, with an approachable tax
authority and relatively quick turn-around times for tax rulings, have been
impacted by COVID-19, increasing the need for TLI as a reliable and quick

Where next?

Ultimately a tax broker’s role is
to ensure that their clients have access to the most comprehensive tax
insurance solutions available at the most competitive prices. In addition to
this, BMS work closely with the tax insurance market to find new and innovative
ways to provide solutions for our clients.

There is an appetite within the
insurance market to provide TLI policies that are more akin to traditional
insurance policies, i.e. an annual renewal providing ongoing cover for certain risks.
The underlying premise for TLI will remain the same, being that a policy is
placed based on the technical analysis of a risk, providing cover for a
challenge by the relevant tax authority of the tax filing position at or before
the date the policy was placed.

This approach is suitable for the
majority of identified risks as the policy typically covers a specific event or
set of circumstances that have given rise to a theoretical risk. However, there
are certain areas of tax that provide an ongoing risk of challenge by tax
authorities and it is those to which the ‘renewal’ concept most effectively
applies, namely transfer pricing (TP) and substance issues.

With both TP and substance
requirements, a corporate group is required to apply the relevant rules to the
operational reality of the business, and provide evidence of this application
using legal documentation in order to defend their interpretation if
challenged. TP has the added complication that ‘regular’ – the insurance market
acknowledges that the meaning of ‘regular’ varies depending on the nature of
the business – benchmarking exercises should be carried out to evidence that the
pricing allocated for the relevant intra-group finance, service or royalty payment
remains a fair reflection of the ‘market’ pricing, as if the payment were made
on an ‘arm’s-length’ basis.

An example of this is Uber which, as previously reported by ITR, is conducting a wholesale review of its TP policy due to a COVID-19 driven restructuring which took place earlier this
year. TLI is not limited to ‘classical’ TP issues. Certain
jurisdictions have introduced additional limitations on the tax deductibility
of intra-group purchases.

“Polish tax regulations limit the tax deductibility of e.g. advisory and
marketing services purchased from related parties, provided that they are not
incurred directly in the production and sale of goods and rendering of
services”, notes Pośniak. “The issue of when such costs are incurred in the
above-mentioned circumstances is perfectly situated for coverage under a TLI

In relation to substance,
although ongoing benchmarking analysis is not required, what may be considered
to be relatively minor changes to a business’ operations may mean it unintentionally
falls below the minimum substance requirements for tax residency status, or equally
unintentionally creates a permanent establishment in a given jurisdiction, both
of which could have catastrophic tax consequences.

As Jones notes “substance is one
of the most important issues for multinational businesses at this time. It is
an area of significant and increasing uncertainty, but also an area where
businesses are applying real focus and endeavouring to ensure their
arrangements have genuine commercial substance aligned with their operations in
the relevant jurisdictions. However, as the question of substance is usually
determined by the tax authorities of counter-party jurisdictions (of which
there can be many), and there can be significant differences in approach and
focus, TLI has the potential to provide multinational businesses with vital
backstop protection in this area.”

Substance issues are closely connected with the verification of the
beneficial owner status. When tax regulations require taxpayers to verify the
beneficial owner status of a counterparty for international tax purposes, TLI
is likely to play an increasing role in managing the risk of an unfavourable
interpretation of the beneficial owner status by the tax authorities. 

The process for extending TP cover

In order to extend the period of
cover for an additional year on a rolling basis, an insurer will typically require
‘top-up’ diligence to be conducted. This means that the businesses’ tax advisors
should conduct a high-level review to confirm that the facts and circumstances
remain as such that no TP adjustment should be required, or that no material
substance risk has arisen. Additional premium will also be due which will be a
fraction of the amount originally paid on the basis the ‘top-up’ policy covers
tax authority challenges in the previous 12 months, thereby providing back to
back cover with the primary policy.

In relation to TP, an updated
benchmarking exercise may also be periodically required in line with what is
considered prudent for the relevant business. Insuring TP adjustments to
finance costs incurs lower premiums and involves a less onerous underwriting
process than service charges or royalty payments due to the wealth of
comparable data available for insurers to rely on.

“Transfer pricing is a good way
of elucidating the differences of appetite in the insurance market. At
Brockwell, we will typically only cover the pricing of shareholder debt backed
by a benchmarking study. However, other insurers may be comfortable with a
wider range of transfer pricing risks.” notes Taylor-Whiteway.

Transact Risk Partners for
example is able to offer cover for goods and services related transfer pricing,
or look into risk where the available documentation is limited. Bos: “If no
benchmark study is available in relation to financial TP, we offer the possibly
of an in-house ‘min-benchmark’ to assess the feasibility of a TP policy. If the
adopted TP position appears feasible, we can then prepare our own benchmark
study as part of underwriting.”


More than half of respondents
(59%) to ITR’s survey on tax controversy said they expect tax authorities to be
more aggressive during TP audits following COVID-19 disruptions and have less
confidence about gaining tax certainty adding even further value to the use of
TLI policies. Almost all advisors and tax directors (94%) surveyed expect more
TP dispute cases in the near-future.

Given the global landscape due to
COVID-19, in conjunction with the approach tax authorities are taking in
relation to transfer pricing and substance in particular, the financial certainty
of tax affairs for businesses has never been more important. Certainty that the
well-established TLI market is well placed to provide.

With thanks to contributions from: Andrzej Pośniak, managing partner and head of tax at CMS Cameron McKenna Nabarro Olswang, Poland; Ben Jones, partner and head of London tax at global law firm Eversheds Sutherland; Sandy Bhogal, tax partner at Gibson, Dunn & Crutcher, London; Richard Taylor-Whiteway, head of tax at Brockwell Capital, London; and Staffan Bos, senior tax underwriter at Transact Risk Partners, Amsterdam.

Dean Andrews

Head of tax liability insurance
BMS Group

T: +44 (0) 20 7480 0308

Dean Andrews serves as head of tax liability insurance bringing more than eight years of M&A experience with some of the largest global advisers. He started his career at PwC, where he provided mixed tax advice to a range of international businesses and their owners, before moving to Eversheds Sutherland, where he primarily advised the private equity community and large corporates.

Dean has been a focused tax insurance broker for several years and has worked with tax advisers and their clients across Europe, the US, India and Australasia on matters ranging from VAT in real estate portfolio disposals to tax credits to share incentive schemes.

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