5.4 It is understandable that the Buyer wants the protection of the tax covenant extended to cover these amounts: the level of the tax losses carried forward may well have featured in his assessment of value when negotiating the price for the shares.
5.5 The impact of the loss of a Deferred Tax Relief is dealt with in the definition of Tax Liability, which is stated to include:
i) the loss, utilisation or reduction of any Deferred Tax Relief which would (were it not for the said loss, utilisation or reduction) have been available to the Company in which case the amount of the Tax Liability will be the amount of Tax which would have been saved if the Deferred Tax Relief had been available;
5.6 We can therefore explore some of the possible events which may result in a loss of a Deferred Tax Relief.
5.7 If it is identified after Completion that there had been a casting error in the capital allowance pool calculations, with the effect that the pool balances were overstated by £100,000, then this would enable a claim to be made under the tax covenant: if the pool had been at the level anticipated the extra capital allowances in the first 4 years would have been £20,000, £16,000, £12,800 and £10,240 respectively. The taxable profits would therefore have been reduced by these amounts and the corporation tax that would have been saved, at a rate of 28%, would have been £5,600, £4,480, £3,584 and £2,867 respectively. The overall value of this loss of a Deferred Tax Relief at a corporation tax rate of 28% is clearly £28,000, yet recovery of only £16,531 has been made in the four years after Completion. As the pool balance halves in value every 3.12 years at an allowance rate of 20%, it takes 6.2 years to recover three-quarters of the pool and 9.4 years to recover seven-eighths, that is 87.5%. 5.8 There is nothing particularly unjust in the above approach: this is the way that the tax would have worked in practice, if the capital allowance pool had been greater to the extent of £100,000. It does, however, place quite a record-keeping burden on the Company: there is a need to maintain a record of the actual capital allowance pool as part of the tax computations. There is then also a need to maintain a shadow pool, so as to track the use of the Buyer’s Relief. 5.9 There are occasions when the tax covenant is worded in such a way that the loss of a Deferred Tax Relief is measured on the assumption that there were sufficient profits to allow the whole of the Relief to be used in the first accounting period after Completion. This is not an acceptable clause as it means that the Buyer gains a benefit which may be greatly accelerated: it is likely to put him in a better position than he would have been in any event. 5.10 Such wording as described above may not enable the whole of the benefit to be accelerated in any event: in the above example it is not a dearth of profits which delays the recovery of the Deferred Tax Relief - it is the operation of the taxing statutes. The above wording therefore creates difficulties in interpretation unless it is also stated that it should be assumed that the lost Reliefs are immediately available, rather than being available in accordance with the tax legislation.
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