Crucially there are measurement differences in respect of deferred taxation: these differences are summarised in this publication.
Many people assume that negotiation and agreement of tax covenants is best done by those with a detailed knowledge of tax legislation, specifically some of the more obscure parts of the corporation tax regime which can be relevant in certain corporate transactions. In fact, the intricacies of the tax covenant are very often related more closely to the rules covering the way that tax liabilities are accounted for in financial statements. Therefore some knowledge of the two accounting regimes of UK GAAP and IFRS, both relating to the reporting of current taxation and deferred taxation, is also very important if the client is to be fully protected.
The tax covenant can therefore be extremely challenging as knowledge is required in three areas:
some of the more arcane aspects of the tax legislation relating to corporate transactions;
the drafting of legal documents;
the way that tax liabilities are accounted for under UK GAAP and, increasingly, IFRS.
Tax covenants include some of the heaviest and most compacted drafting encountered in corporate transactions. They therefore need to be approached with considerable care.
There are many legal and accounting practitioners who appear to approach a tax covenant with a sense of dread and impending doom, as they so often seek to delay its negotiation to the latest possible moment. They then hide behind their computer screen, preferring salvoes of emails as a method of negotiation, rather than having a real engagement with the other side face to face or on the telephone. If they are asked to justify the inclusion of a particular clause within the tax covenant they explain, rather mysteriously, that this clause is now considered as standard. The response to a comment that a particular clause is not needed in this transaction is the sphinx-like retort that its inclusion will therefore do no harm to the other side. These documents cannot be taken lightly. However, we hope that this publication will help readers to navigate through some of the darker and more difficult passages. We also hope that they will be helped in understanding some of the technical tax, legal and accounting issues involved in the various clauses. If this is the case then they will be able to approach these complex documents with greater confidence and obtain rather greater job satisfaction from the experience! The first chapter contains a brief introduction to some of the mysteries of how accounts are bolted together. We hope that this may make non-accountant readers more comfortable in this area. Chapter 2 is a corporate tax computation primer and aims to give a very brief overview of the structure of corporation tax. The third chapter then continues the theme of tax charges, but delves into the world of deferred taxation, as this information can be relevant to understanding tax charges in accounts. Chapter 4 then addresses more deeply some of the tax issues that concern those advising the Buyer and help to provide a backdrop to some of the clauses that are in the classic tax covenant. Chapter 5 comprises a standard tax covenant, for a transaction with completion accounts: this tax covenant is far from being a model as it deliberately includes clauses which we consider to be inappropriate in the context or which are incorrect.
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