Meaning
Contractual clauses in transaction agreements often require one party to protect another from unexpected tax liabilities that arise after a business transfer. A tax indemnity provides this specific protection, ensuring that the seller is held responsible for any unpaid taxes from the pre-sale period. It establishes who must pay for audits, reassessments and legal costs associated with historical tax positions.
This protection is a standard feature of business sale contracts.
Corporate Acquisition
Acquiring a business involves taking on its entire operating history, including its past tax filings and tax strategies. A tax indemnity protects the buyer from the financial consequences of an audit by the revenue authorities after the transaction has closed. If the authorities find that the business underpaid its taxes in previous years, the buyer can claim reimbursement from the seller under this clause.
This protection is often supported by an escrow account or a dedicated tax insurance policy. It allows the transaction to proceed without the buyer needing to fear hidden tax obligations from the seller’s era of ownership.
Risk Evaluation
Thorough due diligence must be conducted before the limits of this protection are negotiated. A tax indemnity cannot cover every conceivable scenario, and it is usually limited by a specific time period and a financial cap. These limits ensure that the seller does not face indefinite exposure to claims after the business has changed hands.
Financial Obligation
Resolving claims under these clauses requires clear documentation and coordination between both parties. When a tax indemnity is triggered, the indemnified party must notify the other party of the audit or assessment immediately. The indemnifying party often retains the right to control the defense against the tax authorities to prevent unnecessary settlements.
This process ensures that the defense is conducted in a way that minimizes the final liability for both parties.
