Insurers have historically been reluctant to provide coverage on tax matters for deals in the Middle East, often excluding tax altogether from insurance policies. However, that is starting to change as the approach of several Middle Eastern countries to taxation is evolving.
An increasing number of M&A transactions in the Middle East are using warranty and indemnity (W&I) insurance to unlock value and optimise transaction outcomes. This type of insurance acts to indemnify parties involved in a transaction against financial losses that could arise out of a breach of warranty in the purchase agreement. In this article, we will also look at tax liability insurance and the growing role of tax insurance as a whole in the region.
Historical background
Whilst the tax insurance market across the U.S., UK and Europe has been booming in recent years, it has lagged behind in the Middle East, where insurer reluctance to provide tax coverage can be attributed to several factors, including the following:
- Limited or non-existent tax regimes in several countries in the region.
- Unpredictable and inconsistent interpretation of relevant tax laws by local tax authorities.
- No publicly available legal precedence concerning tax matters.
- Long statutory time limits.
A shifting tax landscape
In the last 18-24 months, much has changed in the Middle Eastern tax landscape, with the introduction of value added tax (VAT), excise tax and corporate tax across a number of GCC countries.
The region's approach to taxation is significantly influenced by global initiatives like the OECD/G20 Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS). In recent times, tax authorities have become more transparent with the issuance of technical clarifications, supporting cabinet and ministerial decisions/resolutions and supporting guidelines. Furthermore, several of them have undertaken public consultations prior to the introduction of new tax laws or reforms of existing ones. As a result, tax authorities have become more business friendly and consistent in their interpretation of tax issues, while also reducing statutory time limits.
As the region strengthens its tax compliance and governance frameworks, companies are under increased pressure to ensure their tax positions are robust and defensible. Companies are also building up tax capabilities internally to manage their own tax affairs and/or outsourcing tax compliance obligations to reputable professional services firms.
This has therefore given insurers and underwriters increased confidence in insuring specific tax risks across the region.
Tax liability insurance policies
By its nature, W&I insurance is designed to cover unknown risks associated with a transaction. To cover known tax risks, which are typically excluded from W&I cover, businesses can look to tax liability insurance, be it in an M&A context or otherwise.
Tax liability insurance policies are specialized insurance products designed to protect taxpayers against the financial risk of tax-related exposures. These policies can provide coverage for a variety of tax-related risks, including but not limited to real estate taxes, employment tax, corporation tax, point-of-sale tax, share/incentive schemes, capital gains tax and loss of tax reliefs. The insurance provides cover for the underlying tax that may become payable on a challenge and covers the cost of disputing the matter with the tax authorities. Moreover, it offers cover for any interest and penalties that may be levied and an amount for a gross-up in case the insurance payments are taxable upon receipt. The purpose of tax insurance is to mitigate the potential financial impact that may arise from these risks, ensuring that the taxpayer is not unduly burdened by unexpected tax liabilities.
Such policies also allow a seller to access sale proceeds immediately, rather than retaining amounts in escrow or losing value through purchase price adjustments due to the known tax risk.
Tax insurance can also complement a company's tax governance strategy by providing an additional layer of protection and demonstrating a proactive approach to managing tax risk. Untested tax positions are often prone to long-drawn-out and cumbersome litigation. Hence, insurance offers protection against potential financial disruption due to tax leakages.
Process
To place a tax liability insurance policy, insurers are looking for a position that can be defended should there be a tax authority challenge. Insurers often require analysis of the risk itself as well as any relevant documentation supporting the position taken and a calculation of the quantum to be covered (the tax, interest, penalties, gross-up and defence costs). A&M can support clients and insurers in providing the underlying tax analysis by deploying its team of senior tax professionals with significant experience in Middle Eastern tax laws.
Some insurers may require a fronting arrangement in order to have a Middle Eastern entity as the insured. This is typically avoided by having an entity registered in Guernsey, Jersey or "free zone" financial centres in the UAE such as DIFC and ADGM as the insured. Tax insurance policies are also typically governed under English law. There is no requirement for a W&I policy as well, as it is a standalone process/policy and can work independently or alongside a W&I policy.
Pricing
Premium pricing on tax insurance policies varies significantly, depending on the level of risk assumed by the insurers and would be estimated on a case by case basis depending on the risk assessment of the issue. Also, it would be worthwhile to note that the premium paid usually covers a period of seven years which could be extended to ten years in some cases. This ensures coverage for the statute of limitation in most cases.
Conclusion
As the Middle East continues to attract global investment and the market matures, tax liability insurance will play an increasingly significant role in facilitating smooth and secure business transfers in the region, complementing the rising uptake in W&I insurance. In particular, it can provide a safety net for buyers in M&A transactions, ensuring that tax-related warranties are more than just contractual promises.
To better understand how tax liability insurance can help you cover your tax risks, please reach out to the teams at A&M.
Originally published by 18 March, 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
