14.2 Clause 5 deals not only with deductions from payments but also grossing up: as the payment by the Buyer to the Sellers is stated to be additional consideration for the sale shares this clause may be needed: if the Seller is a trading company the substantial shareholdings exemption may have applied, with the result that there was no tax payable on the gain on the disposal of the shares. In other cases there will be tax payable, and the Sellers may therefore need the protection of the grossing up clause. The complexity here can be demonstrated by an example: 14.2.1 Mickfield Holdings Limited is an investment company which owned Mickfield Distribution Limited; it sold its shares for aggregate consideration of £5 million. The base cost of the shares was insignificant. The gain in Mickfield Holdings Limited was taxable at a rate of 28% as the substantial shareholdings exemption did not apply. Mickfield Holdings Limited was then required to pay tax of £500,000 due to a failure by the Buyer to procure payment of a tax liability by the Company. This arose under the provisions of Section 190, TCGA. The payment was stated in the tax covenant to be additional consideration for the shares. It was therefore required to pay tax on this payment by the Buyer. The grossing up clause was therefore invoked, with the consequence that the total sum payable by the Buyer was £694,444. This increased the base cost of the shares in the hands of the Buyer by that amount. However, under the provisions of Section 190(11), TCGA, Mickfield Holdings Limited was able to recover the tax from the Company. If the Buyer had instead procured that the tax was paid to Mickfield Holdings Limited by Mickfield Distribution Limited, then the amount that would have been payable would have been £500,000.
15 Exclusion to Counter-Covenant
10.3 The covenant contained in clause 10.1 shall not apply to a Tax Liability to the extent that the Covenantors are liable to make or have made a payment in respect of that Tax Liability under clause 2 of this Deed.
15.1 This clause should not be accepted unless an appropriate exclusion is also included in the covenant: as has been shown above, there are some instances where a secondary tax liability can be visited on the Company from the Buyer’s Group, in respect of a transaction before Completion. There are therefore two ways in which the Sellers can gain protection from such Tax Liabilities being covered by the undertaking to pay:
15.1.1 an exclusion can be accepted so as to exclude from the coverage of the tax covenant any Tax Liability originating from the Buyer’s Group, excepting the Company; or
15.1.2 the above clause is modified or deleted.
15.2 It is completely understandable that the Buyer wishes to exclude from the counter- covenant any tax which would have been a liability of the Covenantors if the Company had made the payment. However the breadth of this wording does take away the protection for the Covenantors from those tax liabilities which have originated in the
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