Scope and methodology - KPMG Global
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Scope and methodology

Scope and methodology

The tax consequences of applying a warranty clause concern mainly income tax. We have therefore limited our analysis to these areas of direct taxation (excluding VAT, registration duties and any other taxes).


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Scope and Methodology - Tax impacts of warranty clauses

However, we did not want to limit our analysis to the situation of legal entities and have therefore also examined that individual vendor and purchaser, even though cross-border deals most often involve legal entities.

For the purpose of conducting this study, we reviewed tax systems in 25 countries through a comparative study based on answers to a general questionnaire designed to identify the M&A practices with respect to warranty clauses under the legislation of each jurisdiction.

Answers to the questionnaire, listed by country, as well as the tables summarizing the tax treatments of payments made under warranty clauses, both of purchasers and vendor, as well as for target can be found here.

Distinguishing between “price-reduction clauses” and “indemnity clauses”

A comparative analysis shows that the laws of the subject countries generally provide for a mechanism to cover risks via warranty clauses in acquisition deals (question 1 of the questionnaire). It is worth noting that the recent trend in the USA is to dispense with indemnity clauses (when the seller is a financial sponsor), and it is increasingly common for the acquirer to purchase insurance. 

Warranty clauses can be distinguished depending on the type of indemnity they provide. It is therefore possible to distinguish between:

  • Price-reduction clauses - where the value of the target is guaranteed. In such cases, the consideration for the sale can be reduced due to the materialization of future liabilities as defined in the warranty agreement;
  • Contractual liability warranty clauses - where the target or the purchaser can be indemnified upon the materialization of a future liability as defined in the warranty agreement.

Under the legislation of many countries, the tax treatment applicable to contractual warranties will depend on whether they are classified as a price-reduction clause or an indemnity clause. In many jurisdictions, it is relevant to legally classify, directly in the purchase agreement, the financial adjustments arising from the application of such a clause as either a “price-reduction” or an “indemnity.” The recognition of a “price-reduction” clause is the most widespread practice (Australia, Brazil, Finland, France, Germany, Indonesia, India, Mexico and the United Kingdom) (question 6). 

In some countries, such as Australia and the USA, warranty clauses are almost systematically treated as price-reduction clauses (questions 3 and 4). Many jurisdictions, such as Belgium, France and the United Kingdom, have set precise criteria to distinguish between the two types of clauses. The analysis thus most often related to:

(i) the identification of the beneficiary of the payment (the target or the purchaser),

(ii) the amount of the payment (whether or not it can exceed the purchase price) and,

(iii) if applicable, the physical positioning of the clause in the purchase agreement (whether or not it can be inserted directly below the price clause, as it is the case under Belgian legislation) (question 5).

In Mexico, one must examine the methodology to calculate the purchase price to determine the tax treatment of the warranty.

Mixed clauses combining both legal classifications are theoretically possible. However, the study shows that they are infrequently used (except in South Korea) and are generally not recommended because they are a source of complexity (question 3).

In countries such as France, Belgium and India, the tax treatment can be inferred from the legal classification of the payment (question 2). Conversely, in other countries such as the USA and Singapore, such a classification is not decisive. In Spain, the accounting treatment and the date at which the adjustment is made are essential. In Japan and South Korea, it is necessary to refer to the characteristics of the warranty provided (nature and substance).

The warranty clause is generally contained in the purchase agreement for all the countries, and more rarely in a separate document (in South Africa for example). The tax treatment of the adjustment is not, in principle, affected by this (question 7). 

Lastly, the most widespread practice is to determine the amounts of the payments to be made under the warranty clause after taking into account the taxation: as a result, an upward adjustment is made in almost all of the countries in order to take into account the extra tax cost (“gross up” clause), or a downward adjustment in order to anticipate a tax deduction that benefits to the purchaser (question 8). 

Tax regimes that are similar but that most often require an in-depth local analysis

The comparative analysis shows that the amounts received/paid under warranty clauses are treated differently, from a tax viewpoint, depending on the country of residence of the purchaser and the vendor.

No country’s legislation is identical to another’s; however there seem to be two main groups. 

In the first group of countries (Finland, Germany, Hong Kong, the USA and, to a lesser extent, Australia, the Netherlands and the United Kingdom), the financial adjustments are treated in the same way regardless of the characteristics of the clause inserted in the purchase agreement: these adjustments are treated as a reduction of the price of the shares, which results in capital gains in the future.

The payments are therefore not taxable, and correlatively and directly reduce the cost of the share purchase in the purchaser’s books. For the vendor, such payments have the effect of reducing the capital gain or increasing the loss realized.

Of course, there are particularities in certain cases. In the United Kingdom, when the awarded amounts are higher than the purchase price, the surplus may be taxable for the beneficiary. Moreover, when such payments do not match the terms of the purchase agreement, they may not be treated as payments made under a price-reduction clause and thus become taxable for the purchaser without being deductible for the vendor. 

For a second group of countries (Belgium, Brazil, China, France, India, Indonesia Japan, Mexico, South Africa, South Korea,  Spain, Vietnam and, to a lesser extent, Singapore and Switzerland), the tax treatment will depend on the characteristics/wording of the contractual clause.

In these countries, the tax treatment of payments made under a “price-reduction” clause is, in principle, similar to that described above: 

  • Payments are non-taxable at the level of the purchaser and entail a correlative reduction of the share purchase price in the purchaser’s books (when the purchaser is a legal entity); 
  • Payments have the effect of reducing the capital gain or increasing the loss realized by the vendor, subject to local specificities.  

The countries where there are specificities include: Japan, where a payment reducing the purchase price is deductible from the taxable result of the vendor; China, where the actual tax treatment may be subject to the specific contract clauses, relevant accounting treatments and the negotiation with the in-charge tax authority rather than merely to the classification of the warranty from a legal standpoint and Spain, where the amounts received by the purchaser, subject to corporate income tax, are taxable unless specific conditions are gathered notably that the payment occurred within the year following the date of the transaction.

For this second group of countries, the payments made under an “indemnity” clause are, in principle, taxable for the purchaser and deductible for the vendor. Once again, the local tax regimes must be analyzed in depth. For example, the tax treatment in India will in fact depend on the nature of the harm covered by the indemnity: compensation for a capital loss (as opposed to a loss of income) is indeed non-deductible for the vendor and, correlatively, non-taxable for the purchaser. In the same way, in South Africa, the tax treatment for the acquirer depends on the nature of the risk that is being mitigated and the harm covered by the indemnity.

Lastly, it is interesting to examine the case of payments made by the vendor to the target company. The large majority of such payments are taxable (particularly in Belgium, France, Hong Kong, India, Indonesia, Japan and the United Kingdom). The negative impact is nevertheless generally mitigated by the deduction of the liability compensated by the payment.


To conclude, this study shows that the tax treatment of sums received or paid under warranty clauses is not standard across all jurisdictions. 

Although payments are, in general, non-taxable at the level of the purchaser, this is not systematic. Purchasers may indeed be taxed on the sums received in certain situations. Likewise, vendors may in some cases be able to tax-deduct the amounts paid under a warranty clause.

The warranty must therefore be structured by taking into account the tax impacts that may arise as a result of payments made under the clause.

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