November 6th, 2020

Private Equity, M&A and Tax

US cross-border tax issues and the value of tax liability insurance coverage

By: Dean Andrews

Dean Andrews (DA), Division Director and Head of Tax Liability Insurance in London at BMS Group, discusses US cross-border tax issues and the value of tax liability insurance coverage with Ben Furtick (BF), Senior Tax Insurance Underwriter at Certa Insurance Partners.

DA: What kinds of tax issues are insurable in the context of inbound investment into the US?

BF: The flexibility of tax liability insurance to provide coverage for one or more specifically identified potential tax liabilities means tax insurance can be an effective risk management tool in connection with structuring or financing US business operations and managing payment flows into and out of the US. As a non-exhaustive list of examples, creation of a federal or state permanent establishment, tax treatment of financing as debt or equity, tax characterization of payment flows into and out of the US, and application of withholding tax are all issues which may be insurable dependent on specific facts and circumstances.

DA: How can tax insurance help US headquartered multinational groups manage tax issues arising on intragroup restructuring transactions?

BF: Commercially driven corporate reorganizations can often create tax headaches for US headquartered multinational groups due to US companies being subject to tax on worldwide income and the operation of various anti-deferral regimes which have the potential to create dry tax charges. A tax insurance policy can be put in place to back a strong tax opinion on any number of specifically identified tax issues such that US multinationals can limit exposure to low risk tax issues with material associated quantum of potential tax liabilities and can achieve certainty on the economic cost of tax compliance.

DA: Could US headquartered multinational groups make use of tax liability insurance in connection with specifically identified tax issues which arise in jurisdictions outside of the US?

BF: Yes. At Certa, we have underwritten policies to cover potential tax liabilities which could arise in more than 30 different jurisdictions outside the US. Our underwriting team consists of US and UK qualified lawyers and accountants, and we partner with a global network of tax lawyers and accountants to underwrite tax risks in other jurisdictions. Insurability of potential tax liabilities is a function of the strength of a taxpayer’s technical position, a jurisdiction’s level of rule of law and corruption, and the way in which the relevant jurisdiction’s tax authority operates.

DA: Are there any material recent updates to US tax law that acquirers of international business with US operations should be aware of?

BF: The CARES Act provided welcome relief to US taxpayers on a number of fronts, including creation of the ability to carry back net operating losses (NOLs) to offset taxable income from up to 5 previous tax years. Depending on a taxpayer’s facts and circumstances, a tax liability insurance policy can be underwritten to cover a taxpayer’s availability and amount of NOLs to be claimed against prior period taxable income.

DA: Are there unique tax liability insurance policy structure considerations for US named insureds or for policies covering potential US tax liabilities?

BF: Tax liability insurance policies to cover US tax issues are generally structured to pay out in the event of an unfavourable IRS or state tax authority final determination, with covered losses including any tax liability assessed, any related interest and penalties for late payment, and any defence costs in excess of a pre-agreed retention. Policies for US insureds can also be structured to include a gross up for federal and state income tax purposes as proceeds from insurance contracts are generally treated as US taxable income. Policy periods are set in accordance with relevant federal and state statutes of limitation so an insured’s ability to make a claim under the policy aligns to the period during which an IRS or state tax authority audit could be opened.