Share sales – protection against tax liabilities

The exclusion of specific provisions in the sale documentation can put the purchaser in a vulnerable position. They could be unprotected from the risk of pre-completion tax liabilities of the target company that may not have been discerned by due diligence. In order to indemnify oneself against potential tax liabilities, the share purchase agreement should consequently have a covenant and a set of warranties that effectuates the desired outcome.

If any of the warranties that are provided by the vendor prove to be untrue, the purchaser can sue the former for damages. When granting the award, the judiciary will aim to place the latter in the position that they would have been in but for the breach. It is imperative to appreciate however, that only reasonably foreseeable losses are recoverable. Conversely, with a tax covenant the remoteness of damage rule does not come into play the purchaser will receive a sum that is equal to the quantum of any tax liability incurred by the target company. Moreover, under a tax covenant the purchaser does not have a duty to mitigate their loss unless there is an express provision that requires them to do so. This can be contrasted with one’s compulsory obligation to mitigate any loss that emanates from a breach of warranty.

The purchaser may be entitled to claim compensation under the tax covenant for a breach pertaining to a warranty. The share purchase agreement and the tax covenant normally allow the purchaser to choose their preferred route for seeking redress. Even though the majority of claims are made under the tax covenant, there will be rare instances where the purchaser can recover more if they pursue an award of damages for breach of warranty.

It is also necessary to comprehend that tax warranties will cover certain matters that may not be addressed by the tax covenant. With regard to the latter, its purpose is to ensure that the purchaser can protect themselves from tax liabilities materialising on or before completion. Tax warranties however, could comprise representations relating to pre-completion events that affect post-completion tax liabilities.

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