Tax Liability Insurance protects the insured when the tax authority disagrees with a tax position they have taken.

 

Tax liability insurance is designed to address a very specific circumstance rather than provide general coverage. For companies transacting mergers and acquisitions, this can often be more “deal critical,” as tax has a large impact on the upside of any transaction.

Tax liability insurance protects a taxpayer against the failure of a tax position in connection with a transaction, reorganization, accounting treatment, investment, or other type of taxable event.

Specifically, it covers a taxpayer’s losses if the applicable taxing authority deems they have a greater tax liability than what you’ve claimed. Tax liability insurance can cover a particular transaction, such as an investment in renewable energy, or the tax treatment of a non transactional situation, such as restructuring.

The amount of risk the policyholder retains can depend on the standard of the opinion provided to the potential insured by their tax specialist.

Oftentimes, requests for insurance have been driven by new legislation which lacks clarity, precedent or guidance, new case law creating uncertainty, or even growing tax authority aggression.

Furthermore, exchanges of tax rulings/information has motivated taxpayers to seek protection against the increased risk of challenge.

 

Premiums

Premiums reflect the likelihood of a challenge being made by a tax authority in practice, with rates generally fluctuating between 1.5% and 8% of the limit of liability. For matters already before a tax authority, 8%+ is normal.

 

Practical Examples

Practical examples of tax liability insurances can provide an overview of different types of transactional and non-transactional use of such products.

  • Value Added Tax (“VAT”)

Application of incorrect VAT rate towards a given transaction: this risk is especially high in case of so-called comprehensive services whereby there is a main service and secondary service(s) or in case of reinvoicing of services, such as VAT risk management for Real Estate transactions.

In some countries, accurate recognition of tax implications of transfer of real estate which is not considered as transfer of enterprise or its organized part – such transaction may be recognized as (i) subject to VAT, (ii) subject to VAT exemption with possibility to opt VAT taxation, (iii) subject to VAT exemption without possibility to opt VAT taxation.

  • Capital Gains Tax

Capital gains tax on sales by foreign shareholders of certain RE rich companies, to be withheld by such RE rich company - exemption from tax under relevant DTT.

  • Intellectual Property Taxation of Intellectual Property (“IP”) and non-pecuniary assets

In some cases it is possible insuring a reclassification risk that special, more favourable than standard method of accounting for certain earned income related to intellectual property. Furthermore, the circumstances that specific provisions on taxation of transfer of non-pecuniary assets as a result of economic operations (e.g. redemption of shares, liquidation of a company, etc.) were not applied can be insured.

  • Withholding Tax ("WHT")

Withholding tax on interest/dividends/royalties paid to foreign companies on cross border deals can result in exemption or preferential tax treatment which, in some jurisdictions, is often challenged by the tax authority.

  • Thin capitalization

Insurance against risk that tax deductibility of financial costs was not excluded based on thin-cap regulations.

  • Reclassification of B2B contracts into employment contracts

Inuring a potential challenge of engagement structures for board members, whereby their remuneration is split into 2 separate streams: (i) remuneration for management or supervision paid under resolution or management contract and (ii) remuneration for advisory duties paid under B2B contract.

Risk at the side of the employer, due to the fact that it is the employer who performs the function of tax and social security & health insurance contributions remitter in case of employment contract and management contract. Such income is subject to progressive taxation and full social security & health insurance contribution instead of flat rate or lump sum taxation which may be opted in case of income from business activity.

For specific groups of employees (e.g. IT programmers, employees from R&D departments) preferential taxable costs may be applied amounting to 50% of revenue for transfer of copyrights from an employee to its employer.

  • General Anti-Avoidance Rule (“GAAR”) risk

GAAR applicability may be avoided in case there are strong business reasons for conducting the transactions or business operations.