3.2
The Tax Liability with a Corresponding Saving
3.2.1 If there is an unexpected charge for PAYE or NIC or VAT amounting to £50,000, under the classic tax covenant there would be an initial claim under the covenant; there is then the prospect of a subsequent Corresponding Saving, as such a Tax Liability would be a deductible expense for corporation tax purposes. This Corresponding Saving would only result in a credit to the Covenantors when it was used by the Company. Therefore there would be no adjustment if the Company suffered continuing losses in the periods after Completion. 3.2.2 Under the new format, the unexpected charge will meet the definition of an Underprovision: the Tax liability is £50,000, and this is greater than the liability in the Completion Accounts which is nil. As this is an Underprovision it is within the definition of Tax Cost. However, the tax relief available in respect of this liability is £14,000 (£50,000 at 28%). There is therefore an Overprovision in respect of corporation tax of that amount. Under the definition of Tax Cost the Overprovision of corporation tax is deducted from the Underprovision. A claim can be made under clause 2.1 of the tax covenant for £36,000, being £50,000 less £14,000. 3.2.3 Under the classic tax covenant the due date for payment of the £50,000 is 5 days prior to the liability for £50,000 becoming payable to HMRC. There is then the prospect of a Corresponding Saving being repaid to the Covenantors for £14,000 at a later date. Under the new format the £36,000 is payable within five days of being notified. 3.3.1 We shall assume that the corporation tax is underprovided to the extent of £50,000, with £28,000 being due to a bad debt provision of £100,000 being disallowed (£100,000 x 28% = £28,000), and the balance being caused by the disallowance of legal costs of some £78,600. Therefore £28,000 of the adjustment is a timing difference and £22,000 is an absolute difference. The total corporation tax liability is £50,000 greater than the provision in the Completion Accounts. 3.3.2 Under the classic tax covenant there would be a Tax Liability of £50,000 which could be claimed: the general bad debt provision, with an Accounts Value within deferred tax of £28,000, may, in the future, either be released or be turned into a specific provision. Either of these circumstances will then trigger a Corresponding Saving under the classic tax covenant, assuming that the auditors to the Company determine it so. This also requires the Buyer to decide that he will take the action to trigger the Corresponding Saving. 3.3.3 Under the revised tax covenant, there is an Underprovision of £50,000, and this is therefore within the definition of Tax Cost. However, the fact that £28,000 relates to a timing difference means that the deferred tax will be overprovided or understated, (depending upon whether the balance in the completion accounts is a liability or an asset). The Underprovision less the Overprovision or Understatement is therefore £22,000 (£50,000 less £28,000). This is the amount by which the net assets have been overstated. 3.3 The Underprovision for Corporation Tax, Including a Timing Difference
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