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Managing tax risk when acquiring a subsidiary from a consolidated group

Financial, Executive and Professional Risks (FINEX)|Mergers and Acquisitions
COVID 19 Coronavirus|Mergers and Acquisitions

By Alexander Keville , Beatriz Pavón and Stefan Farahani | May 27, 2020

The human cost of COVID-19 remains the focus of people’s attention.

Simultaneously governments and central banks across the world are trying to mitigate the economic impact which is resulting from the disruption COVID-19 is causing to supply chains and everyday lives.

Across Europe we have seen a mix of fiscal and monetary policies seeking to buttress economic activity. Nonetheless, we are anticipating a period of prolonged investment uncertainty at a time when investment will be much needed.

Spain and Portugal are no exceptions and in the coming weeks we anticipate private equity funds will be presented with opportunities to deploy capital in businesses with strong fundamentals, but which have experienced a liquidity crisis due to a drop-off in demand (as well as supply-side disruption). Opportunities will arise, in part, from larger groups choosing or, in some cases, being forced to make disposals of subsidiaries in order to shore up their balance sheet.

Groups in Portugal and Spain are frequently consolidated for tax purposes and operate as a fiscal unity. What this means is that when one buys a company (the “target”) from a larger group (the “group”), often the target could be liable for unpaid taxes of the whole group that it is being acquired from (so called “secondary tax”) in respect of the years in which the target and the group were part of the fiscal unity. This can be a scary proposition for someone interested in buying the target – it is typically impossible for a buyer of the target to undertake due diligence on the totality of the group’s tax affairs as they are only buying the target.

A secondary tax liability has the ability to wipe out the value of an investment in its entirety. The concerns around secondary tax, if left unchecked, can block deals. Our clients have experienced situations where their investment committee has stopped an investment and bank lenders have been unwilling to offer acquisition financing due to the risk of potential secondary tax liabilities. This poses a real problem at a time when investor capital may be needed to rescue strong subsidiaries from struggling groups. Such investment can often help save jobs and preserve long-term shareholder value by avoiding disorderly liquidations.

One might assume that an indemnity from the group to the buyer of the target would be a panacea to secondary tax risks. Unfortunately, an indemnity from the group does not solve the issue – it is exactly the scenario when the group is insolvent that both a secondary tax risk is most likely to manifest and an indemnity from the group will have little value (due to the person giving the indemnity being insolvent).

The solution

Willis Towers Watson has significant experience in arranging insurance of secondary tax risks in Iberia. We have procured insurance in a range of situations, varying from when a group is solvent, distressed and even when a group has already entered liquidation. Pricing for the insurance varies depending on the size of the group in question and its credit quality, but in Spain/Portugal we have seen it range from 2% to 6% of the policy limit purchased.

Insurer's appetite for Spanish and Portuguese tax risks continues to grow. Andrew Thornton of the insurance agency Icen Risk explains “As tax specialist underwriters we have insured secondary tax risks in various European countries and are used to working well with the buyer’s advisors to understand the nature of the fiscal unity and concentrate efforts on understanding the historic tax compliance position of the group”. In order to provide terms for a secondary tax risk, insurers will in particular wish to understand:

  • The nature of the business of both the target and the group – What does it do? How many employees does it have?
  • The due diligence of the target’s tax affairs that has been undertaken.
  • The results of any recent audits of the target and whether the Spanish Tax Authority has recently imposed any secondary tax liabilities.
  • The solvency situation of the group – is it solvent, distressed or in liquidation?
  • Does either the group or the target have any carried forward losses/deferred tax assets?

Similar secondary tax risks also exist in other jurisdictions such as Australia, France, Germany and the Netherlands. An insurance solution is likely to be equally appropriate when buying companies out of larger groups in those jurisdictions.

We anticipate that in due course an increased level of divestiture of minority shareholding will take place, across a broad spectrum of businesses, driven by cash-strapped minority investors looking to exit positions and increase their liquidity. Already a well-established tool for facilitating M&A transactions in many international markets, we expect warranty & indemnity (“W&I”) insurance to expand in significance as counterparty credit risk increases as a result of the COVID-19 crisis. The Willis Towers Watson Transactional Risks Team has analysed relevant past transactions and collaborated with leading W&I insurers in order to bring our clients a summary of some key aspects to consider for W&I insurance in transactions involving minority stake acquisitions.

Disclosure and seller´s knowledge

Amongst the key considerations for a W&I insurer is the disclosure process undertaken by the seller(s) on every M&A transaction. Compared to an acquisition of 100% of a target, where the acquisition of a minority stake is concerned, it is often the case that the majority shareholder is not involved in the sale. This could potentially cause the insurer to approach the deal with caution when quoting terms for a transaction and also during the underwriting process. Depending on the percentage stake being divested, lack of involvement of the majority shareholder could mean that the minority shareholder does not have knowledge of some relevant information by virtue of being a minority shareholder or is not able to get access to such information. It is this uncertainty as to anything significant being missed from the disclosure process that can cause an insurer to have a decreased appetite for the transaction (as they do not have the ability to review the relevant information that supports the warranties provided in the acquisition agreement). Alternatively, the insurer may require a higher percentage premiums than if the entirety of the group were being sold, in order to reflect the increased risk profile.

Can the warranties be given by the management of the target?

In order to address the insurer´s concerns, provide comfort and maximise the coverage position, on recent transactions WTW have advised clients to provide comfort to the insurer by, where possible, involving the majority shareholder in the disclosure process and/ or agreeing with the management board their availability for Q&A by the buy-side. Where the transaction dynamics permit, the insurer often gains comfort where the warranties are given by the management of the target (albeit with limited or nominal liability) in the acquisition agreement or via a management warranty deed, given that it is the management of the company that is most likely to have knowledge of all the key considerations affecting the target.

Other relevant information to be provided

With particular focus on gaining comfort as to the acquisition of the minority shareholding, insurers usually ask to be provided with relevant corporate and company incorporation documents, such as any existing shareholder agreements that may reveal any special rights or liabilities attached to certain shares.

Are synthetic warranties an option?

Sometimes the minority seller or the management many not be in a position to offer any warranties to the buyer. In recent months we have seen an increase in the number of enquiries as to synthetic warranties from our clients, whereby the insured would negotiate a limited set of warranties directly with the insurer and the insurance covers warranties which were deemed given by the seller to the buyer, even though no such warranties were in fact given. This provides a significant increase in protection offered to a buyer. We have explored the possibility of synthetic warranties with the W&I insurance market as a possible solution on various recent transaction but only able to place policies on that basis in a limited number of deals. Historically there is limited insurer appetite for transactions involving only synthetic warranties due to the increased risk profile as described above and lack of market practice in the majority of jurisdictions. However, insurers are showing increased appetite for offering synthetic warranties on deals in familiar territories.

However, as insurer interest and competition in some regions grows, we hope the market will soon evolve so as to cater for this emerging client need at least for some specific business sectors.

Due Diligence

This aspect is linked with the possibility referred to above, that some minority shareholders may not have access to some or all of the relevant information. The scope and depth of the due diligence exercise underpins the coverage position that an insurer is able to provide. A limited due diligence exercise may result in certain warranties either being excluded or partially excluded from cover on the basis of the insurer lacking comfort.

The importance of the scope of the due diligence exercise matching the scope of the warranties cannot be underestimated for minority stake acquisitions, where in light of the possibly limited disclosure process and lack of involvement of the majority shareholder, the insurer looks to gain comfort through other available means. Our recommendation is to ensure that the scope of the due diligence is discussed with your broker at the outset and that the scope matches the warranties you desire cover for.

Policy Mechanics

A buy-side W&I policy for the acquisition of a part of a business will cover the corresponding percentage of any relevant loss. If the insured acquired a 40% stake in the business, the W&I policy would cover 40% of any loss affecting the company which qualifies as “Loss” under the W&I policy.

How do insurers calculate the applicable retention to the policy?

Insurers will often apply the same proportionality principle to the policy retention expressing it as a % of the enterprise value (“EV”) of the target as a whole, rather than just the stake being acquired (transaction value “TV”).

The WTW approach is to seek the most competitive insurer terms for our clients. In our experience we see that the approach followed by insurers depends on the business activity of the target. For Real Estate and Energy sector deals it is frequent to get quotes expressing the retention as a % of the TV but for operational businesses we see that the applicable % is an intermediate range between the TV and the EV.

Seller Tax Risks on Disposal of a Minority Interest

On the disposal of a minority interest there can sometimes be a degree of uncertainty as to the seller’s tax treatment. The seller of shares in a subsidiary would often expect to benefit from a ‘participation exemption’ exempting the seller’s gain from tax. Such exemptions typically require the seller to have held a minimum percentage of the target company’s ordinary share capital for a given length of time. Whilst at face value this would appear to be a straight forward test, there is frequently uncertainty on the exact percentages for tax purposes, when one factors in whether share options, management incentive plans and loans with equity-like features should be included as ordinary share capital and when they were acquired (for example if the options were granted on one day and vested on another).

Where such uncertainty exists, achieving certainty by way of a standalone Tax Liability Insurance policy may be desirable. Such policies are generally taken out by the seller (as it is protecting their tax position) but we have also seen buyers propose such insurance solutions to a seller as a way of enhancing their bid. Pricing for such policies will vary based on the facts but they would typically be between 1.5% and 3.5% of the policy limit purchased. The Tax Liability insurance policy would cover the identified risk and protect the seller against any tax, interest, penalties and legal fees which arise following a tax authority challenge.


In a post-Covid19 M&A market, we expect the competition between W&I insurers to continue in line with the trends observed over the recent years, as insurers continue to grow their teams and expand their competence to local jurisdictions. As a result of this competition we expect greater flexibility from insurers in terms of the coverage position available and the policy pricing parameters to accommodate prevailing market needs.

In a post-Covid19 M&A market, we expect the competition between W&I insurers to continue in line with the trends observed over the recent years.


Alexander Keville
Practice Leader Mergers & Acquisitions,
FINEX Global

Head of Transactional Risks - Southern Europe,
Transactional Risks Team

Director of Tax and Investment Structuring,

Transactional Risks Team

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