Tax liability insurance gaining steam in the M&A market

Tax liability insurance gaining steam in the M&A market | Insurance Business

Tax liability insurance gaining steam in the M&A market

A new insurance trend is quickly gaining steam in the mergers and acquisitions (M&A) market. While transaction liability insurance is common, and representations and warranties (R&W) insurance is standard practice, more and more dealmakers today are starting to use a specialty insurance product to protect against known tax liabilities.

Tax liability insurance has been around for over 10 years, but awareness of the product has only increased recently, with the arrival of multiple brokers and insurers into the market. It is linked to R&W insurance and is often secured in the context of an M&A transaction.

Scott Harty (pictured), partner in Alston & Bird’s Federal & International Tax Group, explained: “Tax liability insurance transfers a known, but uncertain, tax risk from a company’s balance sheet to an insurance company. It is typically asked for ahead of an M&A transaction by a sophisticated seller and during an M&A transaction by a buyer following due diligence, or by a seller who is being asked to give a specific indemnity.”

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The vast majority of tax liability insurance is purchased in the context of an M&A transaction or an investment. However, the product can also be used by a company at any time outside of a transaction, even if a company is under live audit. Typical buyers of tax liability insurance include private equity funds, as well as corporations and private sellers.

There’s a “very broad list of tax risks” that can be insured, said Harty, who focuses his practice on complex domestic and cross-border commercial transactions, including taxable and tax-free mergers and acquisitions, joint ventures, and corporate restructurings. The most common exposures that insureds wish to transfer in the market today include tax credits for renewable energy, real estate investment trust (REIT) risk, and S corporation risk.

Before tax insurance became a viable option, the main ways that companies protected themselves against these known tax liabilities were via purchase price adjustments, escrows, holdbacks, restructuring deals (whenever possible), or self-insurance.   

As awareness around tax insurance grows, insurance brokers can help to differentiate their clients in the marketplace. Harty told Insurance Business: “A good tax risk is generally a risk that is supported by an opinion or well-reasoned memorandum at a ‘more likely than not’ comfort level.

“Risks that are more legally based rather than fact intensive make for attractive risks as well. Brokers can help clients prepare good submissions by being thorough in the up-front work and presenting a strong package to the market. This would include tax advice received by the insured and the supporting documentation.”

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Harty represents clients in domestic and international tax controversy matters, including administrative audits and appeals before the Internal Revenue Service, as well as negotiation and settlement of taxes and civil penalties. When asked whether the increasingly global or cross-border nature of M&A activity is driving growth in the tax liability market because dealmakers are having to navigate multiple tax environments, he replied: “To some extent, yes. Tax insurance is global, and risks can be insured that relate to foreign jurisdictions. The premiums can vary significantly depending on the jurisdiction.

“The main driver of growth is market awareness. R&W insurance has gained acceptance in the market, and tax insurance is starting to gain broader acceptance as well.”