May 2008

Tax Deeds of Indemnities: Issues to Consider

79

Tax Deeds of Indemnities:

Issues to Consider
Gavin OFlaherty Senior Associate, Mason Hayes + Curran

1.

Introduction

certain caveats and exceptions) against certain

liability and protect against any such exposure

In the commercially litigious environment that

tax liabilities of the target company which relate

by any or all of the following:

currently exists, the issue of taxation in the

to a pre-completion period.

context of share acquisitions is one of paramount

importance and requires careful and ongoing
discussion between the client, taxation advisers
and solicitors in order to ensure that tax issues

The particular issues in need of consideration will

generally come to light during the course of the
taxation due diligence.

are properly documented and indemnified

2.

(if required). The main avenue for comfort as

The issues to consider in the context of taxation

regards any pre-completion tax issue that may

due diligence would justify an article in itself.

exist in the target company is to seek a tax

However, in broad terms, the main and primary

deed of indemnity pursuant to which the sellers

purpose of the taxation due diligence is to

or some of them (generally described as the

identify any possible exposure to taxation

covenantors) indemnify the buyers (subject to

Due Diligence

a)

a reduction in the price;

b) a retention from the price by way of

withholding payment for example, by
way of an escrow amount which would
be withheld until the tax issue has been
resolved definitively;
c) seeking the appropriate warranties/
indemnities; and/or
d) considering acceptable tax disclosures
in the context of the disclosure letter.

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Tax Deeds of Indemnities: Issues to Consider

The results of the taxation due diligence will

miscarriage of a primary obligation (such as an

The form of tax deeds has historically been by

ultimately drive the commercial imperatives that

obligation to pay debt, for example).

way of an indemnity whereby the sellers would

will underline the negotiation of the tax deed of

indemnity.

3.

 hat is a Tax Deed

W
of Indemnity?

Taxation tends to be the main issue that buyers

seek protection from; hence warranties and a
deed of indemnity may be required.
The buyer will find that a claim

A number of phrases are used interchangeably

based on an indemnity will be easier

when describing the method by which the

to prove than one for breach of

sellers (covenantors) indemnify the buyer in

warranty.

respect of the pre-completion liabilities of the

target company. In an English Law document
the documents can be described as tax
covenant or tax schedule and are generally
included as a schedule to the share purchase
agreement. In an Irish context, tax covenants
are, in certain circumstances, used in share
purchase agreements reflecting smaller share
purchases. However, it is more standard in an
Irish Law context to see a stand-alone tax deed of
indemnity and this is the type of document that
will be considered further here.

A warranty is a contractual
assurance that takes the form of
statements of fact from the sellers
(or the warrantors) as to the target
companys business, profitability,
and assets and liabilities, for
example. An indemnity is designed
to save the indemnified party from

indemnify the target company regarding this

secondary liability and the document ultimately
expanded over the course of

The tax deed of

indemnity seeks
to allocate risk

time to cover all liability to be

borne by the target company.
However, this practice is now
rarely seen following the case
1

between the sellers

of Zim Properties Limited.

and the buyer,

Although the case did not

whether referable
to completion or
the date of the last
audited accounts.

a specific loss and that party will be

under no obligation to prove that the shares in
the target company are devalued in any way due

actually involve a tax deed,

it is taken as authority that
any claim made by the target
company under such a deed
would be treated in the same
way as the plaintiffs claim
therein and, consequently,

the target company would be fully taxable on the

receipt.

to the event giving rise to the indemnity claim,

Zim Properties Limited, the taxpaying company,

The tax deed of indemnity seeks to allocate risk

which is the case in the context of a warranty

had contracted to sell some of its properties.

(subject to certain specified exceptions) between

claim.

Completion was to take place 12 months later and

the sellers and the buyer, whether referable

to completion or the date of the last audited
accounts, with the broad principle being that
any tax other than tax which has been provided
for in the last statutory audited accounts or
which arises in the ordinary course of the
target companys business since the date of the
statutory accounts, shall be for the account of
the sellers.

4.

Form of Tax Deeds

The background of tax deeds can arguably be

traced back to s46 of the UK Finance Act 1940,
which allowed estate duty to be levied on a
company on the death of a person who had,
during his or her lifetime, transferred property
to the company. This created the unfortunate
situation that the company could be held liable to
an estate duty with no right to recover it (whether

time was to be of the essence to the contract. Zim

was unable to produce a conveyance and hence
unable to show good title due, as it claimed,
to the negligence of its solicitors. The proposed
buyer repudiated the contract, as it was entitled
to do, and Zim issued a writ against its solicitors
claiming damages totalling 104,138 (being
the difference between the agreed price in the
repudiated contract and the monies actually
received when the sale finally went through).

By way of background, an indemnity is a contract

statutory or otherwise). A subsequent UK Income

to protect someone against loss (the loss being

Tax Act (1952) also created a deemed charge for

the hypothetical tax charge). The difference

tax (a surtax) if the company in question did not

between an indemnity and a guarantee is that

pay a full dividend during the relevant taxation

The result of the decision means that any

an indemnity is a separate enforceable contract

period. Again, there was no right of recovery for

payment made to the target company by virtue

while a guarantee is only enforceable (unless

the company in respect of this surtax charge.

of a tax deed would be assessable to corporation

otherwise stated) where there is a default or

1.

Zim Properties Ltd v Proctor (Inspector of Taxes) [1985] STC 90

The action was then settled with the solicitors

agreeing to pay Zim a total of 69,000.

tax without any deduction. To compensate the

May 2008

target for this loss, the seller of the targets

shares would be required to gross-up any
payment under the deed, but this extra financial
burden on the seller is likely to be opposed in
most cases. In addition, the seller would receive
no tax relief for the indemnity payments made to
the target.
The common sense
approach, which is
generally adopted, is to
maintain the tax deed as
a deed between the seller
and buyer of the shares
in the target. As a result,
a payment to the buyer,
as opposed to the target
company, will be treated
by Revenue as a reduction
in the consideration
receivable by the seller
and that payable by the
buyer. As this lowers the
purchase price of the

Tax Deeds of Indemnities: Issues to Consider

5.

Major Provisions in Tax Deeds

5.1 Covenant to pay

A covenant to pay makes the sellers liable to pay
an amount equal to the tax charge levied on the
target company. The amount is limited to the
amount of the tax liability, as the commercial
basis of the tax deed is that, if

The common sense

approach, which is
generally adopted, as a

the company is put back into

the position it was in prior
to the claim, there is no loss.
An example of a form of tax

result a payment to the

covenant would be as follows:

buyer, as opposed to

The Seller covenants with

the target company, will

be treated by Revenue
as a reduction in the
consideration receivable
by the seller and that
payable by the buyer.

shares it will also decrease

the sellers capital gains liability. Furthermore,

the Buyer and (as separate

covenants) with the Company
that, subject to the following

81

when an unexpected liability (or loss of an

expected relief, for example) results in a
payment of tax;
when an expected repayment from the
Revenue Commissioners is not received;
when a requirement to pay tax occurs, which
would have been avoided if an expected relief
had not been withdrawn this type of relief
is generally known as a Sellers Relief for the
purposes of the tax deed; and
when a payment of tax would have occurred
but for the availability of other reliefs (i.e., the
use of relief available to the buyer/buyers and
commonly defined as a Buyers Relief for the
purposes of the tax deed).

provisions of this deed, the

The mechanism for payment is usually triggered

Seller, as directed by the

by the target company receiving a Revenue

Buyer, pay to the Buyer an

Commissioners notice of assessment. From

amount equal to taxation of

a buyers perspective, it should be ensured

the Company resulting from

that any payment obligations under the tax

or by reference to any income,

deed will be triggered prior to any payment

profits or gains earned,

obligation of the target company to the Revenue

accrued or received on or

Commissioners.

before the date hereof.

implication for the buyer. It does remain common

The tax liability should be payable under the

practice, however, to insist on the inclusion of

tax deed whether or not the target company

5.2 What liability is covered or

should be covered by the
tax deed of indemnity?

a clause in the tax deed relating to gross-up

can claim reimbursement from a third party on

There are two basic methods of approaching a

payments in the event that Revenue should

the basis that the buyer should be in a position

tax covenant:

choose to challenge the former suggestion.

to seek immediate recompense from the seller,

there will be no immediate negative tax

The above does not mean that the target

company should not be party to the tax deed
as the target company may need to be party
to the tax deed in order to undertake certain

regardless of whether the claim arises through

the fault of another person. This is the major
difference between a warranty claim and an
indemnity claim.

(i) the first, and somewhat less common

method of structuring a tax deed, is to
provide for a covenant to pay an amount
equal to taxation arising on actual or
deemed profits, income or gains accruing

obligations, such as the provision of information

In summary, a payment will generally be required

on or before completion (being completion

in respect of any future Revenue claim.

pursuant to the tax covenant in the following

of the acquisition of the shares in the

circumstances:

target company); and

(ii) the second, and more frequent method of
structuring a tax deed, is to first split the

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Tax Deeds of Indemnities: Issues to Consider

pre-completion period into the period up

last statutory audited accounts up to

the deed to such an amount as equates to the

to the date of the last audited accounts

completion;

consideration actually paid. When considering

of the target company and, secondly,

the period between the date of the last
audited accounts and completion. The
covenant, in respect of the period from
the date of the last audited accounts
up to completion, covers taxation
arising outside of the ordinary course of
business.

(ii) where the liability was reflected with a

provision or reserve in the last audited
accounts or the management accounts
of the target company provided up to
completion (the completion accounts).
This is a particularly valuable exclusion if
completion accounts are agreed between

this from a buyers perspective, you need to

be careful to ensure that when agreeing to
any such consideration cap, you include in the
computation any liabilities assumed by your
client as part of the share acquisition or promoter
loans repaid, for example, as part of the global
deal.

the parties as completion accounts should

In addition, when acting on behalf of a seller, it

This means that it becomes an important part

provide for taxation in the same manner as

would be important for the purposes of capping

of the drafting process to precisely define and

statutory audited accounts;

the consideration to cap liability at the amount

agree what is a matter, event or circumstance (an

Event) which is outside of the ordinary course
of business of the target company. This means
that if an unforeseen and/or unusual event or
circumstance comes to light post-completion,

(iii) where the liability was caused by a

voluntary act or transaction implemented
at the buyers behest;

restructure and/or reorganisation of the

accounts date, and/or up to completion , which

target company or its group companies

results in a tax liability falling on the target

carried out at the behest of the buyer,

company, then the sellers shall covenant to pay

might be considered;

liability. Following on from that point, any tax

reliefs due to the target company after the last
accounts date should be for the account of the
target company (under the ownership of the
buyer).

5.3 Exclusions to liability

This provision will be of paramount importance
from a sellers perspective as it provides for a set
list of circumstances, which if any of them occur,

(v) failure of the buyer to

make an election to the
Revenue Commissioners;
(vi) a post-completion
cessation of the group
structure of which the
target company might be
a member; or
(vii) if the charge to tax arises

then, notwithstanding that a tax liability of the

as a result of any change

target company does exist, no liability arises for

in the accounting policy

the sellers pursuant to the tax deed. Obviously, if

of the target company

acting on behalf of the buyer, the preference is to

implemented by the

seek as limited a list of exclusions as possible.

buyer post-completion.

Examples of some exceptions include:

(i) taxation arising from the ordinary
course of business from the date of the

for the purposes of the tax deed rather than the

maximum consideration which could be paid to
the sellers (subject to achievement of earn-out

(iv) an exclusion, in respect of pre-completion

during the accounting period following the

to the buyers any amount in respect of that tax

of the consideration actually paid to the sellers

targets, etc).
The parties may also seek to agree a de minimis
claim level below which the seller would not
seek to make a claim

It is also important to
include negligence as an
event that would result in
the time limitation period
being set aside as the
Revenue Commissioners
have the ability in the event
of negligence on the part of
the taxpayer to set aside the
specified time limits.

pursuant to the tax

deed. Some parties
take a view that no
de minimis should be
considered in the tax
deed as the liability of
the sellers pursuant
to the tax deed is, in
essence, an on demand
liability that would not
require the lengthy
contractual process
sometimes involved in
processing a warranty
claim.

The time limitation regarding a tax deed, in a

5.4 Cap or limitation on liability

tax covenant/schedule governed by the laws

This is generally an issue of contention and there

of England and Wales can be upwards of seven

is no set process. Certain sellers advisors can

years. However, it is generally accepted that a

seek to cap the liability of the seller pursuant to

period of five years is acceptable in the context

May 2008

Tax Deeds of Indemnities: Issues to Consider

83

of an Irish Law tax deed. It is important to

jeopardise the target companys relationship

consult with the seller in relation to the Revenue

remember, in the context of agreeing to any such

with the Revenue Commissioners.

application on an ongoing basis.

The issue needs to be considered on a

5.6 Over-provisions

transaction-by-transaction basis. However,

Over-provision clauses are now almost standard

a happy medium can be struck in certain

practice. These clauses seek to govern a scenario

circumstances from a sellers perspective on the

whereby there may have been an overprovision

basis that, if:

for taxation in the last audited accounts of the

time limitation, that the specified limitation

period should be set aside as a result of the
wilful misconduct and/or wilful concealment of
the seller company and/or its directors. It is also
important to include negligence as an event that
would result in the time limitation period being
set aside as the Revenue Commissioners have

(i) the seller provides a full and unconditional

the ability in the event of negligence on the part

indemnity in favour of the buyer in relation

of the taxpayer to set aside the specified time

to the Revenue appeal application; and

limits as set out in the Taxes Consolidation Act

1997.

5.5 Conduct of claims

The provision in the tax deed that generally
arouses the greatest level of discussion is the
conduct of claims provision pursuant to which
the parties agree who
should be entitled to carry
forward an appeal or dispute
of a Revenue claim post-

a buyers perspective, it could be argued whether

then the seller may be permitted to have conduct

of the Revenue appeal claim, subject to keeping
the buyer informed at all stages of the appeal
process. Certain issues might need the specific

Section 629 allows the

Revenue Commissioners
corporation or capital

defending a Revenue claim

when they are safe in the
knowledge that they are
100% indemnified by the
sellers for the Revenue claim
pursuant to the tax deed
and/or they have an escrow
fund available to satisfy any

gains tax from another

member of the group
of companies that the
defaulting non-resident
company was a member
of at the time the gain
was accrued, or from

such liability.

an existing controlling

From a buyers perspective,

director of the company

they will not wish to allow the

ownership of the Revenue
dispute to be ceded to the
seller and thereby possibly

liability of the sellers pursuant to the tax deed or

else a straight cash repayment to the seller. From

From a sellers perspective,

their heart and soul into

a set-off of the over-provision against another

agreements/obligations,

to recover unpaid

that the buyers may not put

to generally provide that there would either be

(ii) provides suitable confidentiality

completion.

the view could be taken

target company. The way to govern this issue is

or a controlling director
at the time the relevant
gain was accrued.

the seller should be protected against its own

mistake of over-providing for taxation. However,
it is a relatively common practice that a provision
along these lines is included in the tax deed.

consent of the buyer such

5.7 Assignment provisions

as the appointment of legal

The buyer may want the contractual ability to

advisers, settlement of the

assign the benefit of the tax deed without the

claim and the forwarding

consent of the sellers and this issue becomes of

of written responses to the

greater importance where the purchase of the

Revenue Commissioners.

shares may be funded by a third party financial

In certain scenarios, the

institution which will want the ability to take an

buyer will wish to provide

assignment of the benefit of the tax deed for

that the seller would not

the purposes of enforcement, should the debtor

be entitled to assume

company default on loans, etc. This is quite

conduct of a claim in the

difficult to resist from a sellers perspective.

event that their legitimate

However, if the wording of the assignment is

commercial interests could

to be accepted it could be provided that any

be jeopardised or where

assignment pursuant to the deed should not

the assumption of the

have the effect of increasing the liability of the

claim by the seller could

warrantors or the covenantors.

have a adverse impact on

the business reputation
of the buyer group

6.

 hat Other Issues Need

W
to be Considered?

(including, for example,

6.1 Pre-sale reorganisations

its relationship with the

There can, in certain circumstances, be a

Revenue Commissioners).

reorganisation and/or restructuring carried out

In such a circumstance, the

in relation to the target company/group prior to

buyer would be required to

completion. From a buyers perspective, it would

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Tax Deeds of Indemnities: Issues to Consider

be important to ensure that a specific clause is

The conservative course of action in this regard

company or a controlling director at the time the

included in the tax deed covering any liability

is to provide that stamp duty would be removed

relevant gain was accrued.

arising out of the reorganisation. It would be an

from the definition of Taxation and that a

important part of the tax due diligence process

separate warranty in respect of stamp duty

to identify the tax issues arising from any such

would be included in the tax deed along the

reorganisation in order to precisely identify the

following lines:

tax risks.

7.

 ompany with Venture

C
Capital/State Funding

Generally, venture capital investors will not be

prepared to give any form of tax indemnity or

The Vendors warrant to the Buyer that all

warranties (save for in respect of title to their

From a sellers perspective, it is imperative

documents forming part of the title to any

shares). This would probably have been a specific

that the Reorganisation is precisely defined

asset of the Company or which Company may

condition of the investment by the VC firm/

however, the sellers will want to resist this as

wish to enforce or produce in evidence are

investor. In addition, in certain circumstances,

it sets out the details of the reorganisation in

duly stamped and have where appropriate

Enterprise Ireland will not provide a tax

a document which may at any time fall into the

been adjudicated. If this warranty is

indemnity on disposal in respect of an investee

hands of the Revenue Commissioners.

untrue with respect to any document and

company in which it held a shareholding.

in the reasonable opinion of the Buyer it

Needless to say, the buyer will want an indemnity

is necessary to procure stamping of such

in respect of 100% of the unexpected

document, then the Vendors shall pay to

tax liability; therefore, this will mean the

the Buyer on demand by way of liquidated

indemnifying sellers may have to provide an

damages an amount equal to any unpaid

indemnity that will proportionally represent a

stamp duty and any interest or penalties

greater proportion of the consideration received

payable in respect thereof.

by them. Say, for example, if two shareholders

If the reorganisation was carried out with the

knowledge of and even at the specific request
of the buyers where, for example, the buyer
did not wish to acquire property interest(s)
held by the target company or where the buyer
did not wish to acquire a subsidiary company
which solely holds property interests, then the
sellers might seek to carve the tax effects of

6.3 Change of tax residence

this reorganisation out from the terms of the tax

From a sellers perspective, s629 TCA 1997 and

deed.

more particularly sub-section 5 thereof needs

6.2 Definition of Taxation

inclusion of stamp duty
A careful issue to consider is the definition of
Taxation in the context of the tax deed due to a
theoretical issue of contention, which might arise
on the basis of section 131 of the Stamp Duties
Consolidation Act 1999. Section 131 of the Stamp
Duties Consolidation Act 1999 provides that any
contract which seeks or purports to indemnify a
party in respect of its liability to stamp duty shall
be void. Following on from that, a view (albeit a

to be considered. The sellers might seek comfort

whereby the buyer would agree to indemnify and
hold the sellers harmless in respect of any tax it

were 40% shareholders in a company which

a noncovenanting VC firm held a 20%
shareholding, the indemnifying sellers will then
in fact be indemnifying the buyer in respect
of 50% of the unexpected tax liabilities of the
company.

(or any other person falling within s629(4) TCA

Conclusion

1997) incurs or becomes liable to pay, resulting

Claims under tax deeds are becoming a

from any action by the buyer, the company or

more regular event and it is imperative that

the subsidiary, which results in the residence of

appropriate tax advice allied with appropriate

the company or its subsidiary being transferred

legal advice is provided prior to and at the

outside Ireland at any time on or after completion

drafting stage in order to safeguard the sellers

and thereby coming within the charge to taxation

or buyers position (as appropriate). The terms

pursuant to s629 TCA1997.

of the tax deed should not be accepted as a fait

conservative one) could be taken that to include

Section 629 allows the Revenue Commissioners

stamp duty (which is technically incapable of

to recover unpaid corporation or capital gains tax

being indemnified pursuant to section 131) in the

from another member of the group of companies

definition of Taxation could taint the deed and,

that the defaulting non-resident company was

thereby, possibly leave it open to an allegation

a member of at the time the gain was accrued,

that the entire deed is void.

or from an existing controlling director of the

accompli, as each transaction may have specific

issues that need specific protection/amendments
to be built into the tax deed.