This guide was last updated in August 2015.

A tax deed is one of the documents dealt with when a buyer purchases a company or group of companies. It sits alongside the share sale and purchase agreement, and will sometimes be drafted as a schedule to that agreement rather than as a separate deed.

When acquiring the shares in a company, the buyer will inherit the tax liabilities of the target company. The tax deed protects the buyer, as it contains (in very basic terms) a promise by the seller to pay the buyer an amount equal to any tax liability arising in the target company in the period before the buyer purchased that company.

What is the purpose of a tax deed?

When a buyer purchases shares in a company and takes over responsibility as owner of that company, it also becomes responsible for the tax liabilities which arise in that company. The purpose of the tax deed is to protect the buyer of a company from any tax liabilities that are referable to the period before the buyer purchased, and became responsible for, the company.

In a tax deed, the seller promises to pay to the buyer an amount equal to any tax liability which arises in the target company which is referable to a pre-completion period or event, but only to the extent that the liability has not already been covered in the target company's accounts. In other words, the tax deed tries to catch unexpected - and unprovided for - tax liabilities.

Unlike warranty damages, which are calculated by reference to the reduction in the value of the target company's shares, the tax deed enables the buyer to recoup the target company's tax liabilities on a pound for pound basis. The tax deed will not normally be subject to the common law duty to mitigate loss, and the ability to recover amounts owing under it should never be limited by reference to any liabilities disclosed by the seller in the disclosure letter.

Although there is some overlap between the tax warranties – see below – and the tax deed, the main purpose of the warranties is to seek information whereas the purpose of the tax deed is to allow the buyer to recover any pre-completion tax liabilities without having to prove fault.

It is sometimes suggested that the buyer will not need a tax deed where the target company has made significant losses. It should, however, be borne in mind that the tax deed will cover not only corporation tax but also VAT, PAYE and national insurance.

It is becoming increasingly common for no tax deed to be given where the sellers are private equity houses, or for a limited tax deed to be given just by management.

What are tax warranties?

Tax warranties are also amongst the documents which are dealt with when a buyer purchases a company or group of companies. The tax warranties are normally included in the warranty schedule in the share sale and purchase agreement, and are given by the seller in favour of the buyer.

Warranties are statements of fact about the target company which can either be positive or negative. Examples include:

  • 'the Company has, within the relevant time limits, paid or accounted for all tax which it is or was liable to pay or account for'; or
  • 'the Company has not within the last six years been liable to pay any fine in relation to tax'.

If this statement is not true, the seller must disclose the extent to which this is the case. For example, using the second example above, if the Company had been fined in relation to tax in the previous six years the seller would have to disclose this fact. To the extent that full and accurate disclosure is made by the seller, the buyer cannot claim for breach of warranty.

Tax warranties can be lengthy, but the main areas cover:

  • tax compliance;
  • tax disputes;
  • group matters (if the target is part of a group);
  • residence and overseas matters;
  • employee tax issues;
  • tax planning.

What is the purpose of tax warranties?

The main purpose of the tax warranties is to elicit information about any danger areas in the target company that may affect the buyer's decision to buy, or that may affect the price that the buyer is willing to offer for the target company.

A secondary function is to provide the buyer with a means of redress if the seller is in breach of warranty. However, in most cases the tax deed will be a better means of redress for the buyer as the tax warranties are subject to disclosure and the duty to mitigate loss.

What information is needed to draft a tax deed and tax warranties?

It is normally the buyer who prepares the first draft of the tax deed and tax warranties. In order to draft or negotiate these documents, the following information will be required as a minimum:

  • outline of the transaction;
  • details of the parties;
  • is it a sale out of a group?
  • are all the sale companies UK resident?
  • is the seller doing any tax planning?
  • how is the consideration structured?
  • are completion accounts being drawn up and, if so, how is tax to be treated in these accounts? Will full provision for tax be made?
  • if completion accounts are not being drawn up, will the last statutory accounts be used as the basis for the tax deed or are other accounts (eg Locked Box, Management Accounts) being used?
  • have any tax issues been identified already, whether through due diligence or otherwise?
  • will all the sellers be giving the tax deed?