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Czech Republic - Tax impact of warranty clauses

Czech Republic - Tax impact of warranty clauses

Tax impacts of warranty clauses in the Czech Republic.

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Czech Republic

Does the seller grant warranties or indemnities to the purchaser when acquiring a company?

Yes, mostly warranties. The provision of indemnities depends on the level of tax risks at stake and negotiation power of the parties.

Does the tax treatment of the warranty depend on its legal classification (e.g. indemnity vs. reduction in the purchase price vs. others)?

The tax treatment depends heavily on the legal framing of the SPA. Typically, where the payments are flowing to the purchaser, they are considered as a purchase price reduction which is not taxable per se but impacts the tax acquisition costs of the shareholding which may impact the future tax on capital gain (if any). Each case must however be examined separately, as there may be exceptional treatments.

If the compensation payment is received by the target, depending on the specific facts and circumstances, it could be considered as an income taxable at the level of the target.

Is classification of the contractual warranties as a price reduction clause or an indemnity clause relevant in your jurisdiction?

Please see the response to question 2. It is generally recommendable to explicitly include in the SPA that the warranty or indemnity claim is considered as a purchase price adjustment.

Are mixed clauses included in the SPA (for instance, a warranty drafted partially as a price-reduction clause for the portion corresponding to the purchase price and as an indemnity clause for the amount exceeding the purchase price)?

We have not seen this in practice. Commonly, the sellers require limit for the warranty/indemnity claims which does not exceed the purchase price.

Is the classification usually mentioned in the SPA?

Yes, the warranties and indemnities are generally clearly distinguished in the contract. Please see also the response to question 3.

Are there criteria to distinguish between a price reduction clause and an indemnity clause? Could you briefly describe these criteria?

There are no specific guidelines or instructions from the Czech tax authorities on this issue. As above, the main distinction between the types of compensation (regardless whether they are called indemnity or otherwise) is seen as to whether the beneficiary of the payment is the target or the purchaser. The applicable accounting treatment may also be relevant to examine.

As noted the ultimate tax treatment needs to be considered based on the actual facts and circumstances.

What is the most common type of warranty in your jurisdiction?

SPA’s involving Czech companies very often include the same types of Seller warranties as may be expected in other international transactions, e.g. concerning corporate matters, legal title, borrowings, financial records, tax, legal and regulatory compliance. Breach of Seller warranties may allow for claim of the purchaser against the Seller for compensation for incurred loss/harm: which is generally seen a s a purchase price adjustment.

Is a tax warranty usually provided by way of a separate warranty agreement (different from the SPA)? Would the tax treatment of the tax warranty then be different from the treatment described above?

Generally it is provided in the SPA, but we have seen situations where the warranties were included into a separate agreement (which was however linked to the SPA). So long as formally and in substance an adjustment to the purchase price the tax treatment should not differ based on whether the warranties are directly in the SPA or in the separate document.

Is it usual / a market practice to negotiate after-tax settlements, i.e. to reduce the price adjustment to a net payment (i.e. indemnity minus the tax effect of the deduction for the acquirer or target) or to guarantee full indemnification (i.e. gross-up payment to guarantee a net indemnity)?

This depends purely on the negotiation power of the parties. We would say it is more common for an indemnity to be net of any tax benefit resulting from the event that created the indemnified liability but we would not necessarily call it a market standard.

Acquirer

  Corporate
Income Tax

Personal
Income Tax

Price reduction clause

The price adjustment should not have direct impact on the taxable income of the purchaser. It is treated as a decrease in the investment value of the shares.

Consequently, future capital gains will be increased.

The price adjustment should not have direct impact on the taxable income of the
purchaser. It is treated as a decrease in the investment value of the shares.

Consequently, future capital gains will be increased.

Indemnification clause It should be generally treated as reduction in the purchase price (please see above). If the indemnification did not qualify as the price reduction, the tax treatment
would need to be analyzed based on the facts and circumstances.
It should be generally treated as reduction in the purchase price (please see above). If the indemnification did not qualify as the price reduction, the tax treatment would need to be analyzed based on the facts and circumstances.

Vendor

  Corporate
Income Tax
Personal
Income Tax
Price reduction clause

The price adjustment is generally not tax deductible. If the price reduction occurs within the tax period (same as the sale), we would presume only the actually realized capital gain would be taxable (if not exempted).

If the reduction takes place in the next year it would need to be analyzed whether
any tax could be refunded to the seller.

The price adjustment is generally not tax deductible. If the price reduction occurs within the tax period (same as the sale), we would presume only the actually realized capital gain would be taxable.

If the reduction takes place in the next year it would need to be analyzed whether any tax could be refunded to the seller.*.

Indemnification clause

Indemnification costs are generally non-deductible if they qualify as a price reduction.

If the price reduction occurs within the tax period (please see above) If the indemnification costs do not qualify as the price reduction, the deductibility would need to be analyzed based on the facts and circumstances.

Indemnification costs are generally non-deductible if they qualify as a price reduction.

If the price reduction occurs within the tax period (please see above If the indemnification costs do not qualify as the price reduction, the deductibility would need to be analyzed based on the facts and circumstances, but note that
the deductibility of costs by an individual is generally often restricted (more than with respect to the companies).

* In any case a thorough analysis would be required to ascertain the appropriate regime given that the companies are sold typically by a holding company rather than directly by an individual.

Target

Price reduction clause
N/A
Indemnification clause

If the payment does not flow to the target, it should not influence the tax position of the target. However, if the target receives the compensation itself, depending on the circumstances such income could be viewed as taxable.

Contact

Patrick Leonard - KPMG in the Czech Republic

Partner, Tax

Tel: +420222123564

pleonard@kpmg.cz

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