Germany - Tax impact on warranty clauses | KPMG | GLOBAL

Germany - Tax impact of warranty clauses

Germany - Tax impact of warranty clauses

Tax impacts of warranty clauses in Germany.

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Does the seller grant warranties or indemnities to the purchaser when acquiring a company?

This is a negotiation issue, but generally yes.    

Does the tax treatment of the warranty depend on its legal classification (e.g. indemnity vs. reduction in the purchase price vs. others)?

The tax treatment does not only depend on the legal qualification in the SPA but also on a thorough wording of the respective warranty (as a price reduction clause) and the economical background.

If the payments are only made between the seller and the buyer this could support the qualification as a price reduction clause and, thus, the payments could only have an impact on the purchase price/capital gain. However, if the payments will also be made directly to the target entity, the respective clause needs to be structured carefully to avoid taxable income at the level of the target entity.

Thus, it depends on the wording in the individual contract whether a payment under a tax clause qualifies as a price reduction or leads to adverse tax consequences.

Is classification of the contractual warranties as a price reduction clause or an indemnity clause relevant in your jurisdiction?

It is generally agreed that a payment under a tax warranty clause shall be treated as a purchase price adjustment.   

Are mixed clauses included in the SPA (for instance, a warranty drafted partially as a price-reduction clause for the portion corresponding to the purchase price and as an indemnity clause for the amount exceeding the purchase price)?

I have not yet seen a mixed clause in this context.  

Is the classification usually mentioned in the SPA?

Yes, it is usually mentioned in the SPA.   

Are there criteria to distinguish between a price reduction clause and an indemnity clause? Could you briefly describe these criteria?

No specific criteria available. This varies case by case and needs to be seen in the light of the respective circumstances in the SPA.  

What is the most common type of warranty in your jurisdiction?

Generally, a price reduction clause.  

Is a tax warranty usually provided by way of a separate warranty agreement (different from the SPA)?

The tax warranty is generally included in the SPA, sometimes as an Appendix.  

Is it usual / a market practice to negotiate after-tax settlements, i.e. to reduce the price adjustment to a net payment (i.e. indemnity minus the tax effect of the deduction for the acquirer or target) or to guarantee full indemnification (i.e. gross-up payment to guarantee a net indemnity)?

If possible and necessary, a full indemnification is negotiated.   

Acquirer

  Corporate Income Tax Personal Income Tax
Price reduction clause The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as an increase/decrease in the investment value of the shares. Consequently, future capital gains will be increased/decreased. The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as an increase/decrease in the investment value of the shares. Consequently, future capital gains will be increased/decreased
Indemnification clause In case the tax clause does not qualify as a price reduction, the payment could trigger taxable income. In case the tax clause does not qualify as a price reduction, the payment could trigger taxable income.

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause Leads to an increase/decrease of the capital gain. Leads to an increase/decrease of the capital gain.
Indemnification clause Tax deductibility needs to be analyzed and depends on the individual situation. Tax deductibility needs to be analyzed and depends on the individual situation.

Target

Price reduction clause Generally, no effect on taxable income of target entity. However, if payment will be made directly to the target entity, the clause needs to be structured carefully to avoid taxable income.

Contact

Stefan Kochs

KPMG in Germany

Senior Manager – German Tax Desk Paris

Tel : +33 (0)1 55 68 14 31

Stefan.kochs@fidal.com

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