In some jurisdictions, the statutory warranties applicable to share deals are limited, so purchasers generally require vendors to commit to contractual warranty clauses covering the assets and/or liabilities of the target company. Such warranty clauses may cover only liabilities, only assets, or both assets and liabilities.
Vendor warranties covering only liabilities aim to protect the purchaser from liabilities not disclosed in the target company’s accounts on the date of the transfer (e.g., an underestimation of or failure to record debt, a guarantee or any other security granted by the target).
In clauses warrantying assets, the vendor assumes liability for any reduction of the company’s assets arising prior to a specific date of reference but not revealed before that date.
Net asset warranties can also be put in place, allowing a set-off mechanism whereby any surplus liability can be offset against any increase in assets.
The drafting and negotiation of warranties in a share purchase agreement or separate warranty agreement is primarily a legal matter. However, the parties should not neglect the tax impacts of warranties in the negotiation process. Poorly drafted warranties can trigger double taxation or fail to take into account the after-tax effects, thereby penalizing one or more of the parties. This study compares the different tax treatments that may be applied to the amounts paid or received under warranty clauses, depending on the countries concerned, in order to provide guidance on how to more efficiently structure asset and liability warranty mechanisms in an international context.
The length of the warranty obligation must also be adapted to take into account the various statutes of limitations applicable to taxes. Likewise, the date of the vendor’s payment of the indemnity should be adapted so as to take into account the due date of the tax liability. These aspects will not, however, be examined in the scope of this study.
This study compares the different tax treatments that may be applied to the amounts paid/received under warranty clauses.