1 Introduction
1.1 As noted earlier in this book, it is our view that the classic tax covenant’s emphasis on the cash flow effects of tax payments can provide a comforting certainty. However the measure of loss that applies for most purposes in corporate transactions is by reference to reductions in the values of net assets. This is the commercial reality of the transaction (if it is recognised that net assets do embrace the elusive wisps of goodwill and other intangible assets). 1.2 As mentioned when exploring the concepts of deferred taxation, if a corporation tax provision is found to be underprovided, it is very likely that the deferred tax provision will be overprovided by the same amount, if it relates to a timing adjustment. 1.3 The mechanics of using cash flows as the measure of loss are inconsistent with the way that financial statements are prepared, as they are based on the concept of accruals. 1.4 For many transactions, notably those where the Consideration is relatively modest or where the deferred tax balances are not a material balance sheet component, it is our view that the price that is agreed for the shares is not determined to any discernible extent by the allocation of tax provisions between those for corporation tax, for other forms of taxation and for deferred tax. If a transfer of the whole of the deferred tax provision into a current liability for corporation tax would not have an appreciable impact on the value of the shares, then we consider that this alternative structure of tax covenant is far more appropriate than the classic tax covenant. 1.5 This approach has a major impact of extending the special protection of the tax covenant to cover any underprovided deferred tax liabilities, in addition to the current protection given in respect of overstated deferred tax assets. It also involves simplification in respect of the timing of Buyer’s Deferred Tax Reliefs again for the benefit of the Buyer. This is balanced by the same timing being applied for the benefit of the Sellers for Corresponding Savings, Overprovisions and Understatements.
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