We recognise that shares in limited companies are amongst the most complex of assets: it is this very complexity that leads to the Buyer seeking whatever protections are available. The protections that the court of custom and practice consider are standard include undertakings to pay in respect of tax liabilities; such protection in respect of other liabilities is not considered as standard practice. Tax covenants are a feature of transactions involving the purchase of the shares of most companies which are not listed or on AIM. The more widely spread the shares, the less practical it is to obtain from the shareholders the protections envisaged in a tax covenant. The protection in the tax covenant takes the form of a series of covenants entered into by Covenantors (normally some or all of the Sellers of the shares). The Covenantors are not actually providing an indemnity against losses, as the losses are suffered by the Company and the Company is not normally a party to the tax covenant. (The reasons for this are explained in Section 3.) Therefore the Covenantors are promising to pay an amount equivalent to the relevant tax paid by the Company.
There are many standard definitions used in tax covenants. The first point to make is that we use the phrases “tax deeds”, “tax covenants”, and “tax deeds of covenant” interchangeably.
We are using many definitions which require no further explanation, such as Completion, Consideration, Buyer, Sellers, Covenantors, etc. However, we are introducing some of our own, which will appear very frequently:
the “Company” refers to the target company which is being acquired;
“Last Accounts” refers to statutory financial statements for the Company drawn up to the latest accounting reference date prior to Completion;
“Completion Accounts” refers to accounts drawn up from the date of the Last Accounts to Completion (usually on the assumption that the level of the net assets stated by these Completion Accounts will determine all or part of the Consideration payable.)
“Stub period” refers to the period between the Last Accounts and Completion, most notably if no Completion Accounts are prepared.
We are using the standard definitions “ITA” to mean the Income Taxes Act 2007, “ITEPA” to mean the Income Tax (Earnings and Pensions) Act 2003, “ICTA” to mean the Income and Corporation Taxes Act 1988 and “TCGA” to mean the Taxation of Chargeable Gains Act 1992. The 2009 Corporation Taxes Act is referred to as CTA.
HM Revenue and Customs are referred to as “HMRC”.
We are also using abbreviations for various taxes, including PAYE, VAT, CGT and SDLT.
There are two main accounting conventions in use in the United Kingdom: International Financial Reporting Standards are now used by listed entities and by companies on the Alternative Investment Market or AIM. These accounting rules and practices are referred to as “IFRS”. Private companies in the UK still mainly use United Kingdom accounting standards and practices and this is referred to as generally accepted accounting principles and practice in the UK or “UK GAAP”. There are many presentational differences between the two systems.
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