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Broadly, W&I insurance protects the buyer of a company in the event that there is a tax claim post acquisition. If this occurs, the buyer can make a claim on the insurance policy. This is usually easier than going into a lengthy dispute process with the seller to recover the tax liability.
The prevalence of tax W&I insurance in deals continues to grow as it is a useful and effective risk management tool. It also has a significant impact on how a tax due diligence is scoped and conducted.
This month, in our M&A series, we share our key practical tips in relation to tax W&I insurance:
It goes without saying that all your advisers should be made aware that W&I will be procured at an early stage. This will impact how the due diligence is scoped and the agreed materiality thresholds for the review.
Importantly, and sometimes overlooked, is that the seller should also be made aware what the W&I process entails. Some sellers may not have gone through a W&I process and will need to be educated on what this means. Their full co-operation and transparency during the diligence process will impact the robustness of the diligence. Ultimately, the quality of the W&I coverage obtained will depend on the sellers’ cooperation and willingness to engage in a comprehensive due diligence.
The scope of the tax due diligence has to be comprehensive in order to obtain full insurance coverage. We do take into account what are ‘market expectations’ based on industry and risk profile. We spend a lot of time understanding the risk profile and where the due diligence efforts should be directed. For example, for a company with an extensive contractor-based workforce, it is clear that remuneration taxes (ie payroll tax, superannuation, FBT) needs to be a key focus.
While the scope and the review process is extensive and detailed, when it comes to the final report… “less is more”. Often insurers and their advisers will review this at the 11th hour and will not have the time or inclination to do a deep dive into a lengthy report. Detailed explanations and discussions on every document that was reviewed in the diligence must be avoided.
We use our experience to describe the risks that exist, quantify them and allocate a risk rating (low – medium – high). Making open-ended statements and inconclusive statements will regularly lead to exclusions in relation to those areas from the insurance.
Exclusions from the standard scope of a tax due diligence have become common. For example, not all open periods are always reviewed. Or a dormant subsidiary could be excluded from the review scope. There could be good pragmatic and commercial reasons for these exclusions. However, it is important to keep in mind any exclusions from the scope of review, which then become exclusions from the W&I insurance policy. From a cost-benefit perspective, it may be advisable to extend the scope to include these items so you will end up with a more comprehensive W&I policy.
With the demand for W&I insurance ramping up significantly over the last year, we are also seeing common exclusions from policies from the insurer’s side. Insurers are now unwilling to take on certain risks due to their present levels of exposure in the market. For example, transfer pricing, JobKeeper claims and availability of tax losses can be common exclusions.
If these are key risk areas, it is important to try to agree a scope of review that ensures coverage is obtained – or make a judgement call on how to proceed. For example, we could socialise such risks early with the seller and ensure any potential escrows are agreed. This avoids transaction stress in the final hours of the deal.
Ultimately, a tax W&I insurance policy is a key risk management tool you should consider to safeguard your transactions. If you decide to procure one, it is important to understand that the tax due diligence process will be very different to what you may be accustomed. As always, early planning and scope refinement are key to obtaining a robust insurance policy to cover your tax risks.
