liabilities between corporation tax and deferred tax liabilities. The corporation tax liabilities would have increased as each of the above adjustments had the effect of increasing the taxable profits; however the deferred tax balance would have moved in a reciprocal way. This is because each adjustment would also have created or increased a Deferred Tax Relief. 23.6 This exclusion is therefore taking the tax covenant away from a relatively close adherence to the cash flows relating to taxation; it is moving more towards the way that tax is accounted for in financial statements: in the same way as there can be frustration with those Inspectors of Taxes who delight in seizing on the sorts of adjustments above, there can be frustration with the way that tax covenants deals with these matters. If a timing difference can reverse, and is very likely to reverse, in the near future, then the use of the ponderous and costly powers in the tax covenant can seem disproportionate. 23.7 We have referred above to a relatively close adherence to the cash flows. There is not always absolute adherence to the cash flows as the cash flows relating to the use or loss of a Deferred Tax Relief can be problematic: if tax losses would only have been utilised slowly, there is a risk that the Buyer will not have been recompensed within 7 years of the date of the Deed. There is a rather greater risk that the Sellers will not be able to gain full recovery of timing differences within the 7 year period. 23.8 The classic response to the above proposed exclusion is to say that the Tax Liability should be paid by the Covenantors and that they should then seek recompense through the Corresponding Savings clause. This can be unwieldy and it may require some relatively complex record keeping: there will need to be capital allowances pools for the tax computations and shadow capital allowances pools to keep track of the corresponding savings. From a practical perspective this can be unduly burdensome, especially on smaller transactions. 23.9 As some understanding of the way that deferred taxation works is important in considering tax covenants, there is an explanation in chapter 3 of this publication. We hope that this will serve as a primer for this area. Deferred tax is part of the mainstream of knowledge for Accountants. However it is quite understandable that solicitors, whose discipline is the management of words rather than figures, may wrestle with some of the concepts above. 23.10 The simple response to the above exclusion is that the classic tax covenant works on the basis of cash flows: this requires timing differences to be ignored and for recompense to be gained from corresponding savings.
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