What is Tax Liability Insurance?
Tax Liability Insurance (TLI) is a specialist insurance policy that protects a business against certain known tax risks. The risk may be historic or may arise from an ongoing transaction. If the tax authority later challenges the position, and the business ends up owing tax, the policy will respond accordingly, covering the tax liability itself along with interest, penalties and the costs of defending the position.
Why businesses may benefit from a TLI policy
Tax consequences for businesses are inevitable, whether on the back of an M&A transaction, reorganisation or other significant business event.
In the context of M&A, Warranty & Indemnity (W&I) covers unknown historic tax risks in relation to a breach of tax warranties or under a tax indemnity. W&I does not cover known tax risks.
Where a risk has already been identified, the parties may be left exposed and will often deal with such an issue via specific indemnities or purchase price adjustments. This uncertainty can, in some cases, cause a deal to fall over. TLI addresses this gap by covering the known risk, giving both sides the confidence to proceed.
Outside of the transaction perimeter, companies often retain material tax liabilities on their balance sheets which can be transferred to the insurance market. Transferring these liabilities from the balance sheet to an insurer can free up capital, improve a company’s cash flow position and provide comfort to investors. This is particularly valuable when a fund is being wound up or in the case of liquidations, giving the directors/liquidators comfort to approve the wind-up or return of funds without waiting for the limitation period to expire.
What is covered?
A TLI Policy protects an insured from certain known tax risks which are considered unlikely to crystallise but would be costly if they did (typically, low probability and high severity risks). The risks may be historic or potential future risks arising from an ongoing transaction.
The range of tax liabilities covered range from customs, duties, capital gains tax risks to the availability of tax credits and withholding taxes. Cover extends from the tax liability itself to penalties and costs of defending an assessment if a tax authority challenges the position. These risks are often identified during tax due diligence.
What is not covered?
Cover is subject to the specific terms of the policy. TLI will not cover fraud, deliberate non-disclosure or new tax liabilities created by future changes in the law.
How the policy works?
Tailored to one risk: These are bespoke, non-recurring policies, specific to the relevant tax risk.
Policy period: The policy period usually tracks the statute of limitations. A 7-year period is standard but can sometimes extend up to 10 years. This can vary by jurisdiction and by the nature of the risk.
Find out more
If you expect to encounter these risks in your business or in preparation for a transaction, please reach out to our Transaction and Contingent Risks team to discuss how you may protect against these risks.
