United Kingdom - Tax impact on warranty clauses | KPMG | GLOBAL

United Kingdom - Tax impact of warranty clauses

United Kingdom - Tax impact of warranty clauses

Tax impacts of warranty clauses in United Kingdom.

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

Yes.

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

No. See detailed comments below. The tax treatment depends on (i) the beneficiary of the warranty or indemnity payment (purchaser or target company), (ii) the amount of this payment (exceeding or not the purchase price) and (iii) the terms of the SPA (if the SPA provides for the payment).

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

Yes. See detailed comments below.

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 of this kind are not common.

Is the classification usually mentioned in the SPA?

Warranty/indemnity payments are typically stated in the SPA to be treated as far as possible as an adjustment of the consideration.

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

A payment made by the vendor to the purchaser under a warranty or indemnity included as one of the terms of the SPA is treated for tax purposes as a price adjustment for both parties.

If the payment exceeds the purchase price, the excess is likely to be taxable for the purchaser.

If the beneficiary of the warranty/indemnity payment is the target company (as opposed to the purchaser or where the purchaser directs that payment to the target), the receipt is likely to be taxable in the hands of the target.

If the warranty of indemnity payment is not made in accordance with the terms of the SPA it may be taxable in the hands of the purchaser i.e. not treated as a price reduction.

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

A price reduction clause is more common in the case of quantifiable, certain of high risk tax exposure items (e.g. part of the net debt adjustment in completion or locked box accounts), but it is also common to see a specific tax indemnity (tax deed or covenant) forming part of the transaction documentation in addition to general (including tax) warranties.

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

Warranties are normally included in the SPA. Tax indemnities are normally contained in a separate deed of covenant: this might be an Appendix to the SPA or a separate document. Provided the warranties and/or indemnities form part of the overall sale agreement, the particular way they are documented does not change the tax treatment.

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, it is a market practice to negotiate after tax-settlements and the most common practice is to guarantee full indemnification by a gross-up payment.

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 in the investment value of the shares. Consequently, future capital gains will be increased. If the payment exceeds the purchase price, the excess is likely to be taxable. Moreover, if the payment is not made in accordance with the terms of the SPA it may be taxable The price adjustment has no direct impact on the taxable income of the purchaser. It is treated as a decrease in the investment value of the shares. Consequently, future capital gains will be increased.
If the payment exceeds the purchase price, the excess is likely to be taxable. Moreover, if the payment is not made in accordance with the terms of the SPA it may be taxable.
 
Indemnification clause Provided the payment forms part of the terms of the sale agreement (in the SPA or a separate document), it is treated as a decrease in the investment value of the shares. Consequently, future capital gains will be increased.
If the payment exceeds the purchase price, the excess is likely to be taxable. If the payment is not made in accordance with the terms of the SPA it may be taxable.
 
Provided the payment forms part of the terms of the sale agreement (in the SPA or a separate document), it is treated as a decrease in the investment value of the shares. Consequently, future capital gains will be increased.
If the payment exceeds the purchase price, the excess is likely to be taxable. If the payment is not made in accordance with the terms of the SPA it may be taxable.
 

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause The price adjustment is treated as a decrease in the sale price of the shares. Consequently, the capital gain is decreased. The payment is treated as a reduction in the sale price therefore any taxable gain on disposal is decreased.
Indemnification clause Provided the payment forms part of the terms of the sale agreement (in the SPA or a separate document), it is treated as a reduction in the sale price of the shares. Consequently, capital gains on disposal are decreased.
If not, the payment is not treated as a price reduction and may not be tax deductible.
 
Provided the payment forms part of the terms of the sale agreement (in the SPA or a separate document), it is treated as a reduction in the sale price of the shares.
Consequently, capital gains on disposal are decreased.
If not, the payment is not treated as a price reduction and may not be tax deductible.
 

Target

Price reduction clause Receipt by the target is likely to be taxable, either by way of a reimbursement of tax deductible expenditure or as a capital gain.

Contact

James Madams – KPMG in the UK
Senior Manager – Deal Advisory, M&A Tax
Tel: +44 (0) 20 7311 4824
james.madams@kpmg.co.uk


Philip Brook – KPMG in the UK
Partner – Deal Advisory, M&A Tax
Tel: +44 (0) 20 7311 4865
philip.brook@kpmg.co.uk
 

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