1 Introduction
1.1 There are several distinct undertakings to pay that the Covenantors make relating to Liabilities to Taxation. The distinct situations normally covered are dealt with below.
1.2 As previously mentioned, the modern tax covenant is no longer an indemnity as the Company is not a party. Therefore the effect of the wording used above is that the Covenantors will pay an amount equal to any Taxation Liability. This is now the standard means of identifying the amounts due from the Covenantors. As previously noted, this is an undertaking to pay. There is not a general requirement for the Buyer to mitigate and there is no requirement to prove any loss, other than evidence that the Tax in question has arisen. 1.3 The above drafting takes account of circumstances where claims under the tax covenant may exceed the consideration payable: this could be the case if the Consideration was a nominal figure due to the net liabilities of the Company or the level of trading losses being incurred. 1.4 Payments made by the Sellers to the Buyer will be taxed on the Buyer under the provisions of Section 22, TCGA, being a capital sum derived from assets. From a practical perspective this means that there should be no tax payable up to the limit of the Consideration paid for the shares, but the capital gains tax base cost of those shares will be reduced. Payments in excess of the Consideration will be taxed on the Buyer under Section 22, TCGA. 1.5 If there is a grossing up clause, which is a standard feature of tax covenants, the Covenantors should be aware of the additional cost arising in these circumstances. For a high proportion of transactions the ceiling placed on claims will be no greater than the Consideration, so this should not be a major concern in such cases. If this is not the case, then it is very important that the Sellers are aware of the additional cost exposure. 1.6 The tax position of the Sellers is that the consideration that they have received is reduced by covenant payments under the provisions of Section 49, TCGA. Although the legislation only refers to a warranty or representation, HMRC confirm that they extend this meaning to include payments under tax covenants. However such reduction of the proceeds can only be to £ nil. Any payments which make the consideration essentially negative are considered by HMRC not to trigger capital losses for the Sellers.
1.7 The Covenant is constrained and trammelled by a series of exclusions and these are dealt with in the next chapter.
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