Tax Insurance: Mitigating Potential Pitfalls in Corporate and Debt Restructures
In light of the current economic climate, most corporations have experienced some degree of financial stress. This has resulted in corporate boards, management teams, and private equity funds deciding to restructure financing arrangements to bolster liquidity, and will lead to a rise in group reorganisations to ensure businesses are poised for both resilience and growth.
A level of tax uncertainty is often inherent in the case of restructuring or refinancing. The steps required to implement these types of transactions are complex, and if a tax authority successfully challenges a tax position, the result may be a significant amount of financial loss. Marsh’s tax liability solutions can be used to mitigate these risks through the use of tax insurance.
Summarised below are some of the key risks to consider when contemplating a corporate restructure or refinancing exercise, such as restructuring of debt and recapitalisation, and how tax insurance may assist in relation to known and unknown tax risks.
Corporate groups, in a distressed situation or otherwise, often undergo restructuring in order to wind up unprofitable operations, enhance alignment across business units, reduce overall costs, or optimise the structure for a carve-out of underperforming assets. In any group restructure, there are usually a number of associated tax risks that will need to be carefully considered and mitigated to the extent possible.
Typical tax risks that can arise due to a group restructure, which may be covered by a tax insurance policy, include:
- Capital gains tax and eligibility for “rollover” relief
- The imposition of foreign country taxes on indirect transfers
- Stamp duty and potential exemptions
- Impact on the future availability of losses
- Application of anti-avoidance rules
In this regard, the use of tax insurance should be explored in the following scenarios:
1. Coverage of specific tax risks instead of risk retention or tax clearance
Sometimes the tax law and/or its application to a particular set of steps in a restructuring plan may be uncertain. In such cases, the taxpayer will normally choose to either: (i) proceed as planned and bear the potential tax risk that has been identified, or alternatively (ii) seek a tax ruling from the relevant taxation authority to confirm the tax position. Retaining the risk could result in a significant financial exposure should the tax liability crystallise in the future. Meanwhile, seeking a tax ruling is often not practical as it can take an extended period of time to finalise. In addition, the outcome of a tax ruling application is not certain.
In contrast, obtaining insurance coverage for the specific tax risk can be done relatively quickly and achieves an effective transfer of risk while enabling a high degree of control over the process.
2. Coverage of unknown tax risks in a restructure
Tax insurance is most commonly used as a means of mitigating one or more of the specific tax risks that arise in a restructuring context. However, in some cases, a corporation may also wish to insure the restructuring plan as a whole, to essentially obtain protection against potential “unknown” tax risks that could be triggered as a consequence of the restructure. These unknown risks comprise potential tax exposures, which are not identified and addressed in the restructuring plan and related tax advice.
Marsh has developed a policy solution for the Pacific region, known as ‘Restructure Tax Insurance’, which is intended to provide coverage for unknown tax issues that arise in respect of a restructure or refinancing. We recognise that these transactions involve a varied and potentially far-reaching set of tax risks, and understand how important it is for clients to be able to shield themselves from surprise tax liabilities and the related financial burden. This coverage will be helpful for a wide variety of transactions, but will be particularly beneficial for restructures involving a high level of complexity or where a number of jurisdictions are involved.
3. Implementation of restructuring steps
The tax consequences of a particular restructuring plan are often subject to that plan being implemented in a specific manner. Insurance coverage can be obtained to protect the expected tax outcomes based on the form and substance of the legal documentation that is put in place to effect the implementation. This type of insurance can be used on a stand-alone basis or as a supplement to the Restructure Tax Insurance discussed above.
Debt restructuring and recapitalisation processes are undertaken for a number of reasons, including optimisation of the debt and equity funding mix, avoiding default on loans, or to bolster cash reserves when a liquidity buffer is needed. These transactions can lead to significant and unexpected tax outcomes. For example, the tax laws regarding debt forgiveness, anti-hybrid instruments, transfer pricing and thin capitalisation may be invoked in any number of scenarios involving the financing arrangements of a business, which may include:
- Extinguishment of all or part of existing intercompany loans, or revision of interest rates between related parties
- Debt-equity swaps or other variation of debt or equity instruments
- Write-down of book value of assets and impact on the level of allowable debt in a structure
The potential adverse tax implications stemming from the above debt restructuring scenarios may include a reduction in tax attributes (such as losses and cost base of assets), the disallowance of interest deductions, or the inclusion of amounts as assessable income. To the extent there is significant uncertainty over whether the taxation authority may challenge a particular tax treatment, the option of mitigating such risk through tax insurance should be explored.
Businesses often undergo some form of corporate or debt restructuring in an endeavour to optimise their operating structure and ensure they have an appropriate funding mix. Equally, private equity firms and strategic investors will commonly undertake restructuring to protect their investments, especially during challenging economic conditions. Tax insurance can support these processes, providing greater financial certainty at a time when liquidity and balance sheet protection are critical to continued business sustainability.
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Please note: Marsh Pty Ltd (ABN 86 004 651 512, AFSL 238983) arrange the insurance and is not the insurer. This document and the analysis provided by Marsh (collectively, the ‘Marsh Analysis’) are not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Any statements concerning tax or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as tax or legal advice, for which you should consult your own professional advisors. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Except as may be set forth in an agreement between you and Marsh, Marsh shall have no obligation to update the Marsh Analysis and shall have no liability to you or any other party with regard to the Marsh Analysis or to any services provided by a third party to you or Marsh. Marsh makes no representation or warranty concerning the application of policy wordings and no assurances regarding the availability, cost, or terms of insurance coverage. The Marsh Analysis includes a general policy overview. For full details of the terms, conditions and limitations of the covers and before you decide whether a policy suits your needs or making any decision about whether to acquire the product, refer to the specific policy wordings. LCPA No. 20/224.