India - Tax impact on warranty clauses | KPMG | GLOBAL

India - Tax impact of warranty clauses

India - Tax impact of warranty clauses

Tax impacts of warranty clauses in India.

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

Yes, the purchaser may ask for an upfront reduction of the purchase price or holdback arrangements or just mere indemnities depending on the level of the tax exposure involved.

If any probable exposures are not factored in for an upfront purchase price reduction or price holdback arrangements, then such exposures are normally factored in for an indemnity clause, which would normally become payable on occurrence of the exposure.    

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

Yes, there are no explicit provisions in tax law dealing with a payment of indemnity and therefore the tax treatment of each indemnity needs to be determined based on their legal characterization and prevailing tax jurisprudence.    

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

Yes.   

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)?

Generally, there are no such mixed clauses. Either an indemnity is treated as a reduction in the purchase price or a recoupment of a particular expense or loss.  

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?

There are non-specific criteria. It all depends on the intent of the contracting parties and how that intent is documented in the SPA or warranty agreement. An unambiguously written up clause is required so that the parties’ intent can be clearly deciphered.  

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

Generally, the purchase price reduction clause is more prevalent.  

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

Both ways are possible. The tax treatment does not depend on where the tax warranties are written up.  

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)?

Yes. Normally, this is the practice.   

Acquirer

  Corporate Income Tax Personal Income Tax
Price reduction clause If the payment is treated as a reduction of the purchase price, it would not be subject to tax. If the payment is treated as a reduction of the purchase price, it would not be subject to tax.
Indemnification clause If the indemnity is characterized as revenue (rare): it would be taxable. If the indemnity is characterized as capital: it would not be taxable. If the indemnity is characterized as revenue (rare): it would be taxable. If the indemnity is characterized as capital: it would not be taxable

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause The Vendor is not liable to withholding tax on the payment. The Vendor could revise his tax return claim to reduce capital gains tax on the transaction. The Vendor is not liable to withholding tax on payout of the indemnity. The Vendor could revise his tax return claim to reduce capital gains tax on the transaction.
Indemnification clause Normally, the payment of the indemnity is considered as not pertaining to the business of the Vendor and therefore is not tax deductible. If the Vendor is engaged in the business of trading of shares, the indemnity payout may be deductible. If the indemnity recipient is taxable, the Vendor may need to withhold appropriate taxes. Normally, the payment of the indemnity is considered as not pertaining to the business of the Vendor and therefore is not tax deductible. If the Vendor is engaged in the business of trading of shares, the indemnity payout may be deductible. If the indemnity recipient is taxable, the Vendor may need to withhold appropriate taxes.

Target

Price reduction clause If the indemnity is characterized as revenue (rare); it would be taxable. If the indemnity is characterized as capital; it would not be taxable.

Contact

Prinut Shah

KPMG in India

Partner – Tax and Regulatory Services, M&A Tax

Tel : + 918049255353

prinut@kpmg.com
 

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