Executive Summary
A It is not necessary for the Company to be a party to the Tax Covenant. If the Company is a party, this creates the potential of extra cost to the Sellers, with no commensurate benefit for the Buyer, apart from the protection of its capital gains base cost in the shares of Company. B It remains virtually universal for Tax Covenants to include a “grossing up” clause, so that the Buyer is due to receive amounts in excess of the taxation in question if the receipts from the Sellers are themselves subject to tax. We find it difficult to think of circumstances in which the Sellers should agree to the grossing up clause being included in the tax covenant if the Buyer insists on the Company being a party. This would result in the protection of the base cost of the Buyer being at the expense of a cost to the Sellers. C If the Tax Covenant provides for it to be assigned, either within the Buyer’s group or elsewhere, it is important that the Tax Covenant provides that the “grossing up” clause should then cease to have effect: this assignment will have otherwise worsened the tax position of the Sellers in respect of payments made under the Tax Covenant. The common alternative is to state that assignment is not to increase the Liability of the Sellers. D It is possible for the Buyer to direct that the proceeds of any claim should be paid to the Company rather than to him, should he so wish. This does not jeopardise the position for the Seller provided that the Company does not have any contractual entitlement to the claim under the tax covenant. The funds are considered to be constructively received by the Buyer, even if directed to the Company. E If the ceiling on claims under the Tax Covenant exceeds the Consideration, such as in situations when the Consideration is nominal, amounts paid to the Buyer under the Covenant may well be taxable on him. In such a circumstance the grossing up clause would apply, to increase the effective amount of the payments to be made by the Sellers. The Sellers need to be aware of the additional exposure in this area. F The counter-covenant given by the Buyer to the Covenantors requires a grossing up clause in favour of the Covenantors, unless the Company is a party to the tax covenant in respect of the counter-covenant. This then may create possible financial assistance issues for public companies, under the provisions of the Companies Act 2006.
G There has been no requirement for many years for the tax covenant to be in the form of a deed.
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