Hong Kong - Tax impact on warranty clauses | KPMG | GLOBAL

Hong Kong - Tax impact of warranty clauses

Hong Kong - Tax impact of warranty clauses

Tax impacts of warranty clauses in Hong Kong.

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

Yes this will almost certainly be included in the SPA.    

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

Generally not. Both should be characterized as an adjustment of the value of the cost base of the shares of the company acquired/sold. Such adjustments are generally capital in nature and then not subject to taxation.    

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

Contractual warranties are separately classified as either indemnities or reductions of the purchase price (the SPA should specifically state how tax warranties are to be claimed).   

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)?

Mixed clauses can be included in the SPA.  

Is the classification usually mentioned in the SPA?

Yes, the SPA should provide for specific mechanisms for claiming tax warranties / indemnities.   

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

A purchase price clause is a mechanism whereby any tax warranties claimed may be factored into the calculation of the purchase price, whereas an indemnity payment may be claimed after the sale (with limits on liability) and might be offset against an escrow account. The tax implications of using either a purchase price adjustment or an indemnity payment should generally be the same.  

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

Warranties could take the form of a price reduction or an indemnity. It is a matter of commercial consideration.  

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

A separate tax deed is not common, but possible. In case of a separate tax deed, the tax treatment would not be different.  

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)?

Full indemnity of the actual tax liability is normally provided.   

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 a decrease (or increase) in the investment value of the shares. Consequently, future capital gains will be increased (or decreased).* The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as a decrease (or increase) in the investment value of the shares. Consequently, future capital gains will be increased (or decreased).*
Indemnification clause In general, indemnification payments received should be classified as an adjustment to the cost base of the investment acquired. Consequently, future capital gains will be increased (or decreased).* In general, indemnification payments received should be classified as an adjustment to the cost base of the investment acquired. Consequently, future capital gains will be increased (or decreased).*

* However, Hong Kong does not tax capital gains.

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause The price adjustment would either increase or decrease any gains derived from the disposal. If the assets disposed are capital in nature, the resulting capital gains/losses would be non-taxable/non-deductible. The price adjustment would either increase or decrease any gains derived from the disposal. If the assets disposed are capital in nature, the resulting capital gains/losses would be non-taxable/non deductible.
Indemnification clause In general, indemnification payments should be classified as an adjustment to the cost base of the shares sold. Consequently, any capital gains would be decreased (or increased). The adjustment should not be deductible in Hong Kong. In general, indemnification payments should be classified as an adjustment to the cost base of the shares sold. Consequently, any capital gains would be decreased (or increased). The adjustment should not be deductible in Hong Kong.

Target

Price reduction clause Nil effect on target as the indemnity received is then used to pay the tax liability

Contact

Darren Bowdern

KPMG in Hong Kong

Partner

Tel : +852 28267166

Darren.bowdern@kpmg.com
 

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