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

United States - Tax impact of warranty clauses

United States - Tax impact of warranty clauses

Tax impacts of warranty clauses in United States.

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

Generally yes, although the recent trend is that when a financial sponsor is the seller there are no indemnities. In these cases it is increasingly common for the acquirer to purchase insurance in case the representations and warranties are incorrect.

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. An indemnity should generally be treated as a reduction of the purchase price. It is common for the parties to agree to report all indemnities as purchase price adjustments, although the agreement is really not needed, as this is generally the law.

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

See above – response to question n°2.

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 never seen a mixed clause.

Is the classification usually mentioned in the SPA?

Yes, almost always.

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

Generally not. If the indemnity is to compensate the buyer because of a breach of warranty it should be treated as a purchase price adjustment.

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

Purchase price adjustment.

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

No.  

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)?

It is common for an indemnity to be net of any tax benefit as a result of the underlying event that created the indemnified liability. It is also common for indemnities to be “grossed-up” if they are subject to tax, although, as mentioned above, this would not be expected in practice.

Acquirer

  Corporate Income Tax Personal Income Tax
Price reduction clause The price is deemed to be reduced, which results in capital gains in the future. The price is deemed to be reduced, which results in capital gains in the future.
Indemnification clause The price is deemed to be reduced which results in capital gains in the future. The price is deemed to be reduced, which results in capital gains in the future.

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause No effect. Reduces the gain or increases the loss on sale.
Indemnification clause No effect. Reduces the gain or increases the loss on sale.

Target

Price reduction clause Will still be treated as an adjustment of the purchase price: constitute a deemed capital contribution

Contact

Russell J. Pinilis – KPMG in the US
Principal M&A Tax Group
Tel: 212-954-3098
rpinilis@kpmg.com
 

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