Tax insurance
IPA Insolvency Practitioner newsletter, February 2025
Article from IPA key supporting sponsor Marsh.
Please note that guest content does not necessarily represent the views of the IPA.
In the complex landscape of insolvency, practitioners and their stakeholders face numerous challenges. Tax insurance policies are becoming increasingly popular as a means of protecting against financial losses that may arise if the insured tax treatment is challenged by tax authorities. As companies navigate the winding paths of liquidation or restructuring, tax insurance emerges as a strategic tool for these practitioners, providing a means to mitigate risks associated with potential tax liabilities that can derail transactions, reduce creditor recoveries and expose practitioners to potential claims.
Tax insurance policies are increasingly popular and are used to provide protection against financial losses suffered in the event that the insured tax treatment is challenged by the tax authorities. By providing this safeguard, tax insurance can protect insolvency practitioners, enabling them to wind up companies more efficiently with the confidence needed to release funds more swiftly.
A tax insurance policy typically provides coverage for a period of seven years. It includes protection against tax liabilities, fines and penalties, interest, legal defence costs and tax gross-up. Premium rates for tax insurance policies in the UK have been reducing over the past couple of years, and are currently typically between 1% and 2% of the insurance limit, depending on the risk. This is a one-time payment.
Historically, tax insurance policies have been deployed to transfer tax risks associated with merger and acquisition (M&A) transactions. For instance, a seller may obtain a policy to back an indemnity, or a buyer may secure one if the seller is unwilling to stand behind the liability. This would also often avoid the need for an escrow mechanism or price chip.
However, tax insurance can also be obtained independently of transactions and may be used to mitigate or eliminate exposure associated with historical tax positions. It is frequently used in the context of corporate restructurings or liquidations, providing an additional layer of protection in these complex scenarios. We have set the importance of tax insurance from an insolvency practitioner’s perspective below:
- Mitigates tax risks: Insolvency practitioners often face uncertainty regarding potential tax liabilities that may arise during the liquidation or restructuring process. Tax insurance can cover any potential known low risk or low/medium tax exposures, allowing practitioners to manage the financial position of the company with greater confidence. This assurance can enable them to release funds to creditors or reinvest in the company without the fear of financial loss in respect of the potential tax exposure.
- Addresses historical tax issues: Companies facing insolvency may have unresolved historical tax issues, such as audits or disputes with HMRC, such as the application of tax reliefs, VAT treatment of transactions or transfer pricing arrangements. Tax insurance can provide coverage for these historical tax exposures. By mitigating these risks, practitioners can reduce negotiation time and secure better sale terms, and also free up funds that would otherwise be held in reserve to cover potential tax liabilities, allowing for distribution to creditors or reinvestment in the business.
- Alternative to tax clearance: Sometimes the tax law and/or its application to a particular risk may be uncertain. Obtaining tax clearance from HMRC is often recommended by tax advisors to confirm the tax position. However, the process often takes a long time, which is not practical in the case of timing pressures. As a result, tax insurance is becoming an increasingly popular alternative. The tax insurance process is typically quicker and does not require disclosure to tax authorities, helping to avoid delays in distributions and insolvency proceedings.
- Enhances creditor confidence: Creditor confidence is vital in insolvency situations, as it can influence the willingness of creditors to accept proposed plans or settlements. By obtaining tax insurance for a known tax exposure, insolvency practitioners can demonstrate to creditors that they have taken proactive steps to manage tax risks.
- Supports restructuring efforts: For companies pursuing a restructuring strategy rather than outright liquidation, tax insurance can help manage tax risks associated with the restructuring. This can include coverage for potential tax risks arising from debt forgiveness, asset transfers or changes in ownership structure.
Recent Case Study
A UK-based company undergoing insolvency had a significant live tax dispute with HMRC, relating to historical input VAT claims, with the total potential exposure in the region of £50m. The company was part of a VAT group, where some subsidiaries remained profitable and were in the process of disposing their portfolio of freehold properties to a third-party buyer, while the solvency of others and repayment of parent entity loans were dependent on the outcome of the tax dispute. As members of the VAT group, all the company were jointly and severally liable for the disputed VAT liability, creating a major obstacle for completing the transaction.
To address these concerns and eliminate the VAT risk, thereby preventing the subsidiaries from being perceived as insolvent and ensuring the repayment of loans to the parent entity, the insolvency practitioners worked with Marsh McLennan to obtain a tax insurance policy. The policy not only mitigated the VAT risk but also facilitated the loan repayment to the parent entity, allowing the parties to move forward with the transactions.
Conclusion
Tax insurance serves as a vital tool for insolvency practitioners, offering the certainty and protection needed to navigate the complexities of insolvency. It mitigates tax risks, addresses historical tax issues, facilitates asset sales, enhances creditor confidence, and supports restructuring efforts, enabling practitioners to manage the insolvency process more effectively. As the insolvency landscape evolves, tax insurance will increasingly play a crucial role in safeguarding the interests of creditors and stakeholders.
Practitioners should engage with Marsh McLennan early in the process to assess potential risks and explore coverage options. In an era of heightened scrutiny and economic uncertainty, tax insurance offers a strategic advantage in insolvency and restructuring scenarios.
For further information please contact:
Kate Howard
07385 403705
Please note that guest content does not necessarily represent the views of the IPA.