1.4 It is our experience that all too often the first draft of the tax covenant has not been amended correctly to reflect the mechanics of the transaction. It is therefore most important that the practitioner makes sure that he understands the basis on which each transaction is to take place. He can then ensure that the tax covenant is properly drafted in this area.
2 The Issue: the “Pivot Point”
2.1 If there are to be no Completion Accounts, the tax covenant will largely “pivot”, from an accounting perspective, on the Last Accounts. If there are Completion Accounts then the tax covenant will pivot on these Completion Accounts. 2.2 This pivot point is important in ensuring that the appropriate exclusion is drafted for the tax covenant: there should inevitably be an exclusion to the covenants that no claim arises under the tax covenant to the extent that provision was made for the tax liability in the relevant accounts. (As stated earlier, the essence of a tax covenant is to provide protection against unexpected tax liabilities. If the tax provision is included in the accounts of the Company, the Buyer is aware of the liability and its existence can be factored into the price.) Such tax provisions are not always separate lines on the balance sheet; they may be part of larger balances, but this is not a material issue: if the provision or liability is included in the accounts, then the net assets have been reduced. It is a question of fact as to whether or not a provision has been made. If the deal does not involve Completion Accounts this first exclusion in the tax covenant needs to refer to the Last Accounts. If there are Completion Accounts this first exclusion needs to refer to the Completion Accounts. 2.3 It is understandable that the Buyer will need the protection of the tax covenant for the whole of the period up to Completion: if there are to be no Completion Accounts it will be little solace for the Buyer that the unforeseen tax liability arose in the period between the Last Accounts and Completion. 2.4 The technical problem that arises is that the tax covenant is generally structured so as to define unforeseen tax liabilities as those which are not provided for in financial statements or accounts. If there are no Completion Accounts then the taxes arising between the Last Accounts Date and Completion cannot be measured on this basis.
3 The Solution
3.1 The way that this is dealt with is simple: for transactions where Completion Accounts are not involved, the unforeseen tax liabilities relating to the period from the Last Accounts Date to completion are defined as those which do not arise from the normal course of trading or business activities of the Company. 3.2 The main operative section of the tax covenant therefore covers all tax liabilities up to the point of Completion, as previously. There is then the usual exemption relating to amounts provided for in the Last Accounts or paid prior to that date. However a further
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