Meaning
A specialized insurance product protects a policyholder against financial losses resulting from an adverse ruling by tax authorities on a specific position. Tax risk insurance covers the tax itself and the associated legal costs. It is used when a company takes a technically sound but potentially controversial stance on a complex transaction.
This tool allows for the removal of tax contingencies from financial statements, which can increase the valuation of a business during a sale.
Policy Trigger
Payment occurs only after a final determination by a court or a settlement with the revenue office. Tax risk insurance does not cover known liabilities or existing audits that have already reached a conclusion. The policy is usually tailor made for a specific tax issue identified during the due diligence process of a merger.
Risk Transfer
Shifting the burden to a third party insurer improves the credit profile of the borrowing entity. By using tax risk insurance, a manufacturer can proceed with a reorganization without worrying about a future tax bill that would cripple its cash flow. Lenders are more likely to provide financing when the potential for a large, unexpected tax demand is insured.
Underwriting Depth
Insurers require a detailed legal opinion from a reputable firm before they will write a policy. The pricing of tax risk insurance depends on the perceived strength of the legal position and the reputation of the jurisdiction involved. High premiums reflect a greater chance that the tax authority will challenge the filing and succeed in court.
