Indemnification Recoveries in M&A: Drafting Tax Benefit Offset Provisions

Tax Reporting Issues for Buyers and Sellers

Note: CPE credit is not offered on this program

Recording of a 90-minute premium CLE video webinar with Q&A


Conducted on Wednesday, September 1, 2021

Recorded event now available

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Course Materials

This CLE course will examine the nuances and pitfalls of tax benefit offset provisions in acquisition agreements. The panel will discuss arguments for and against such provisions and how buyers and sellers can best approach the complexity in calculating tax losses or benefits associated with indemnity claims in public and private company acquisitions.

Description

M&A sellers often argue that the amount of any indemnification claim made by a buyer for a breach of a representation should be reduced to the extent the buyer can benefit from a deduction for the amount related to the loss or damage for tax purposes. This might result in the inclusion of a tax-benefit offset (TBO) provision in the acquisition agreement. Care must be taken to ensure that if a TBO provision is included in the agreement that it is correctly conceived and effectively implemented.

There can be uncertainty in calculating the value of a purported tax benefit to a buyer. A variety of competing tax reporting positions can reasonably be taken, and the opinions of tax experts can differ. Different reporting positions could lead to different outcomes and different tax-effected indemnification amounts.

Tax accounting issues must also be considered. A buyer's outlay to address a negative event or condition will not, in and of itself, generate an expense that the buyer can immediately deduct for federal income tax purposes. The actual tax benefit can vary depending on the tax year in which it is recognized and whether it occurs in the context of an asset or stock deal.

In practice, TBO provisions effectively call for subtracting the amount of actual tax paid by the buyer from the amount of tax that would have been paid without the tax-reducing item. But this raises several questions: When must the tax-saving be actually realized by the buyer? Should the buyer be required to seek tax benefits? What role does the seller have in the buyer's tax strategy? Is the buyer protected from future tax audits or liability?

Listen as our authoritative panel discusses the key issues in drafting TBO provisions and the arguments for and against including them in a merger agreement.

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Outline

  1. Tax deductions associated indemnity claims: is there a basis or rationale for including TBO provision merger agreement
  2. Conceptual problems with TBO
    1. Is there any real basis for the premise that the buyer could derive a tax benefit from this situation
    2. If the buyer does derive a tax benefit, why should it go exclusively to the seller
    3. What obligation does the seller have to defend the position if challenged by the IRS or to indemnify the buyer if the challenge is successful
    4. What rights does this type of provision directly or implicitly give the seller to second guess the buyer’s reporting positions
    5. Variations in tax reporting: who gets to decide
  3. Drafting TBO provision
    1. Calculation issues
    2. Timing: when must the tax benefit be realized and reported
    3. Buyer's duty to mitigate losses

Benefits

The panel will review these and other noteworthy matters:

  • Tax deductions associated with indemnity claims
  • Complexities with tax benefit offset provisions: accounting treatment and tax reporting
  • Drafting TBO provisions: calculation, timing, buyer's duty to mitigate

Faculty

Corrigan, John
John F. Corrigan

Attorney
John F. Corrigan Law

For decades, Mr. Corrigan has lent his experience in business law, commercial law and transactional work to businesses...  |  Read More

Lundsten, E. Hans
E. Hans Lundsten

Senior Counsel
Adler Pollock & Sheehan

Mr. Lundsten advises owners of closely held businesses, corporations, governmental entities, universities, and movie...  |  Read More

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