A key document in transactional practice is the share purchase agreement (or SPA). This document contains provisions governing, among other things, the terms of the transaction, the payment of the price as well as financial settlements between the parties, their obligations and responsibilities. It is the primary document negotiated between the parties to cover tax matters. In recent years, particularly in transactions involving certain countries, SPAs are accompanied by tax deeds. A tax deed is a separate document dealing with the tax matters agreed upon between the purchaser and the seller.
From the purchaser's perspective, the purpose of both documents is to provide for the situation where the company is purchased and, subsequently, it turns out that its tax treatments prior to the transactions were incorrect. If this happens, the company may be liable for underpaid tax, interest (which can be high, particularly if a tax inspection reveals tax treatment mistakes made a few years prior) or even additional penalties.
To ensure the best possible protection for itself against existing or past tax arrears of the acquired company arisen before the acquisition, the purchaser will normally try to obtain certain warranties and/or indemnities from the seller as regards tax matters.
The purpose of the warranties given and the representations made by the seller is to ensure that, generally speaking, the company has complied with its tax obligations in accordance with the applicable regulations. In theory, it may seem that to have a claim against the seller it will be sufficient for the purchaser to prove that the seller is in breach of the general warranty that the company calculated and paid taxes as required by tax regulations.
In practice, however, such a claim will be possible if the purchaser obtains specific warranties as precise as possible and reflecting the nature of the acquired company’s business and the information obtained by the purchaser in the transaction process, including during discussions with the seller and from the due diligence (if conducted). As a result, such warranties should address, depending on the situation, general matters (e.g. correct bookkeeping, compliance with deadlines for paying taxes and filing tax returns), but also more specific issues, covering correct tax treatments of sensitive transactions (e.g. correct application of reduced VAT rates, withholding tax), the preparation of complete transfer pricing documentation or the maintenance of all the documents required to claim the 0% tax rate in the case of export transactions or intra-Community supplies of goods.
What is important to ensure a successful potential claim is that the seller's warranties given to the purchaser should not be based on subjective factors, i.e. the seller's knowledge, its familiarity with the applicable regulations or its awareness of certain circumstances. Examples of expressions used to weaken the strength of warranties include "to the best of the seller's / the company's management's knowledge" or "the seller is not aware".
An alternative method of protecting the purchaser's interests is the so-called indemnity clause, which will normally be used in a share purchase agreement if the due diligence examination reveals any irregularities regarding the company's tax treatments. It is less burdensome for the purchaser to pursue claims against the seller under an agreement with such a clause than it is on the basis of warranties. In the case of a claim based on a warranty, the purchaser will have to prove the seller's breach of the warranty and that the purchaser did not know of the breach and suffered damage as a result of the breach. In such a case, the success of the claim may depend on the construction of specific provisions of the share purchase agreement.
If the share purchase agreement contains an indemnity clause, the occurrence of a specified event resulting in the seller's liability will be a sufficient basis for the purchaser's claim. Such events may include, for example, the issue of a decision to assess the amount of underpaid tax and the related obligation to pay the tax, without the purchaser having to prove any other circumstances of the event.
Given the nature of the indemnity clause and the fact that the benefits for the indemnified party are considerable, the use of the clause is limited to cases precisely specified in the share purchase agreement, i.e. the occurrence of which stems from the events indicated and relates to taxes specified in the agreement, with the purchaser's maximum liability under the clause strictly limited to a specified amount (if the parties have agreed upon such an amount) in respect of one event and/or all the specified events jointly.
Both the indemnity clause and the seller's warranties are time-limited and should last no longer than until the expiry of the company's tax liabilities.
At this point, it is worth noting the increasingly popular and important additional agreements that more and more frequently accompany share purchase agreements, i.e. tax deeds, already mentioned at the beginning of this article. A tax deed is a separate document signed by both parties together with the SPA. This document originated in English law and is a very practical instrument used by the parties to a transaction to provide for the steps to be taken in the event of the occurrence of certain circumstances specified in it and related to tax matters. Given the fact that tax matters are currently a highly sensitive aspect of transactions due to significant changes to legislation and the practices of tax authorities, a tax deed will usually provide that the seller is fully liable for the company's tax arrears relating to the period before the closing date of the transaction.
A tax deed provides for situations where the seller’s liability for the company's underpaid tax may be triggered, e.g. in the case of a tax inspection at the company which covers certain taxes or tax issues, or the assessment, by a tax authority, of the amount of underpaid tax, or a tax authority's refusal to make a refund of VAT to the company, etc. If an SPA is accompanied by a tax deed, then if a specified event occurs, the document will clearly state how to deal with it and how the parties should work together if a tax dispute with the tax authority arises, e.g. which of the parties will manage the dispute. Other matters agreed in a tax deed may include keeping the other party informed of the status of any matter that may affect their financial settlements connected with tax-related warranties, or provisions for incurring and accounting for the costs of such matters, or making decisions about formal appeals. In addition, the parties may decide to include an indemnity clause in a tax deed rather than the related SPA.
Given the pace of amendments introduced to both Polish and international legislation, the changing decisions of the courts and inconsistencies in tax authority decisions, appropriate warranties and indemnity clauses covering the company's tax settlements should be among the purchaser's priorities when negotiating the terms of the SPA. Tax underpayments are real money and may seriously affect the profitability of the purchaser's investment. It is, therefore, advisable to include appropriate safeguards in share purchase agreements.
Katarzyna Nosal-Gorzeń, Partner in the Tax M&A Team at KPMG in Poland
Tomasz Jobda, Senior Manager in the Tax M&A Team at KPMG in Poland
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