How can tax insurance be utilised to help your business?

What is tax insurance?

Tax insurance, or tax liability insurance, is a specialist type of insurance that covers loss as a result of tax positions or tax treatments being successfully challenged or disallowed by a tax authority.

Tax insurance is flexible in the way it is structured and designed, but will typically cover the consequences of the specific tax event being successfully challenged including additional taxes which may be due, penalties, interest and gross up (where applicable, depending upon the jurisdiction). It is also usual to build in cover for other costs that a taxpayer may incur such as legal costs in defending any challenge, which can be significant.

The detailed terms of a tax insurance policy are relatively flexible and are based on the specific circumstances            at hand. Tax insurance can be used to cover all kinds of taxes, direct and indirect, whether the risk be within the UK, in Europe, the US or further afield. A tax insurance solution can also be designed to cover more complex multi-faceted risks such as global transfer pricing or where there are different jurisdictions effectively competing for tax on the same income.

The typical length of a standard policy is 7 years however there is flexibility and this can be tailored to the needs of the client or with reference to the applicable statute of limitation or terms of a transaction.

When might it be useful?

As a tax insurance policy is tailor-made to the specific circumstances of a taxpayer, it can be useful in a whole range of scenarios. We typically work with our clients to consider how to use a tax insurance solution in the context of a merger or acquisition, and increasingly common now is as a risk management tool during a business’s ongoing operations.

Mergers and acquisitions

During an M&A transaction where due diligence identifies a significant tax risk, the entire transaction can be at risk of falling through, if not carefully managed. Typically, tax risks will be identified during due diligence which the buyer or its advisors perform on the target entity. In those circumstances, tax insurance can be used to ring fence the identified tax risks and remove them from the deal negotiations. This prevents the buyer from being able to price-chip and avoids the need for funds to be taken away from the seller and being placed into an escrow account pending resolution of the risk.

It is common for buyers and sellers to disagree over the gravity and quantum of a given tax risk and so tax insurance helps to prevent a stalemate in negotiations, allow the transaction to proceed and to provide peace of mind for both seller and buyer.

It is also possible to utilise tax insurance in cases where an M&A transaction has already taken place, and where there were warranties or escrows put in place to manage identified tax risks. Tax insurance can help bring about certainty in the transaction and unlock funds that may be held in escrow or eliminate the need for ongoing warranties.

Risk management tool

Tax insurance can be obtained to cover a tax position (such as ‘uncertain tax positions’) that a business has taken historically, or is planning to take in the future. In these cases, tax insurance coverage is sought to protect against the scenario where the position is subject to scrutiny by tax authorities as part of the businesses ongoing operations. In such a case, tax insurance can provide certainty, allowing clients to focus on running their business rather than looking over their shoulder, fearing correspondence from a tax authority arriving at their door.

Recent developments in this space

The tax insurance market is rapidly expanding and maturing. There are more insurers offering to write tax risks and this has resulted in a number of benefits for those seeking coverage:

1. Premium rates have reduced over the years making tax insurance a more affordable option than it once was.
2. An increased pool of insurers means that the scope of tax risks able to be covered is wider. This includes the jurisdiction in which the risk sits as well as the type of tax risk. There is now increased appetite for providing coverage for what were thought to be complex areas such as transfer pricing.
3. There is scope for covering larger risks, with many underwriters able to cover risks valued at hundreds of millions of pounds/dollars.
4. The key to securing tax insurance is now a well-structured technical opinion covering the likely financial risk outcomes which allows the insurer to review, rather than re-create the wheel and do its own work, which has usually been significant already.

What does the process look like and how can we help you?

The process for securing tax insurance can be complex and time consuming however, Kennedys are well placed to manage the process on your behalf, ensuring it runs smoothly. It is possible, with the right preparation and expertise, to have tax insurance incepted in a matter of weeks.

1. We perform an initial assessment of the tax risk to determine whether tax insurance is likely to be beneficial for you and how best to structure any tax insurance solution. We will reach out to our contacts in the insurance market (on a no names basis) and confirm the appetite for insuring the specific risk, so that we can give you an early indication of whether insurance is likely to be palatable.
2. We prepare a tax opinion/memorandum, or commission one to be prepared by one of our partner firms (depending upon the jurisdiction). An opinion/memo is essential to allow the insurance market to get an initial understanding of the facts and the risk.
3. We work with a trusted broker in the relevant jurisdiction who, after working with us to understand the risk fully and conducting an evaluation of the risk, will approach the relevant insurance market and procure indications from the insurers whether they are interested in providing coverage and if so, the costs associated with that.
4. We liaise with you and the broker to select the insurer which best fits your needs, and we will carry out negotiations on your behalf to ensure we get the best deal.
5. After selecting an insurer, that insurer will use their own underwriting team to review the tax opinion and any other relevant documentation. This is a form of due diligence and can result in the insurer seeking further factual information, clarification on the risk analysis and sometimes requires an ‘underwriter call’ where we will discuss the matter with the insurer’s underwriting team.
6. Whilst the due diligence stage is ongoing, the policy negotiations will also begin. We will perform detailed policy negations on your behalf, reviewing the policy wording and working with our specialist insurance colleagues to ensue that the wording is as favourable as possible to you.
7. We will finalise matters and manage the final binding stages and payment of premiums on your behalf. 

What makes us different?

Our Tax Disputes and Investigations team has significant expertise in delivering tax insurance solutions for our clients, including large-scale multi-jurisdictional projects covering many millions of dollars. At Kennedys, our approach to tax insurance is to offer our clients full project management of the process. This means that we will actively manage every step of the process, leaving you to focus on running your business with peace of mind that you are getting the best outcome for your circumstances.

Kennedys is a leading law firm in the insurance space and so we are assisted by a substantial team of insurance lawyers. That means we have the relevant insurance specialists in-house to perform detailed policy reviews and ensure that we get the best outcomes for you when it comes to policy negotiations. We understand the insurance market inside out and that sets us aside from many other tax disputes teams.