An ongoing issue for M&A transactions involving targets in Vietnam is the uncertainty over the seller’s ability to successfully claim capital gains tax (CGT) exemption under the prevailing tax treaty. The conditions for exemption may be subjective and challenging to interpret, and this may hinder the transaction especially if offshore sellers and buyers are involved.
Figure 1: Typical transaction structure for investments in Vietnam
Hence, this tax issue is heavily-debated between buyers and sellers, which affects the transaction timeline due to uncertainty on whether the seller can claim CGT exemption and make a ‘clean exit’.
The alternative to prolonged negotiation is to cover the potential tax liabilities using tax liability insurance, which allows the buyer and seller to proceed with confidence regarding the tax issue.
Let’s take a closer look at two possible scenarios.
Scenario 1: Using indemnity or escrow
For M&A transactions involving the sale of Vietnamese targets, it is a common strategy for the seller to claim CGT exemption under the tax treaty. This is done to mitigate any exit taxes on gains derived from the sale of a Vietnamese entity by foreign investors.
However, the assessment of CGT exemption claims ultimately remains at the discretion of the local tax authorities. As such, there is a significant risk that the seller may be unsuccessful in claiming CGT exemption.
Even though the CGT is imposed on gains derived by the seller from the sale, the buyer is required by law to file and pay taxes to the tax authorities on behalf of the seller. If the tax authorities assess that there is CGT to be paid, the tax authorities will impose tax liabilities (including interest and penalties) on the buyer if taxes are not filed and paid accordingly.
One way for the buyers to safeguard against these outcomes is by seeking an indemnity from sellers or insisting that a portion of sales be placed in escrow to cover potential tax liabilities. However, this will involve the locking up of capital and prevent the sellers from making a “clean exit”.
Scenario 2: With tax liability insurance
When indemnity or escrow is replaced by tax liability insurance, the coverage can serve as a strategic tool to mitigate the risk of uncertainty on tax liabilities, bridge the gap between buyer and seller, and facilitate the completion of the deal.
Moreover, with tax liability insurance in place, the seller will be able to make a “clean exit” and unlock valuable cash for reinvestments or distributions to investors.
As shown in the diagram below, the process of obtaining a tax liability insurance policy can run parallel to the transaction timeline so that the policy can be incepted on or before the signing date.
Figure 2: Process and timing considerations for tax liability insurance
To help ensure the tax liability insurance policy is aligned to both the buyer’s and seller’s interests, the Marsh Private Equity and M&A (PEMA) team should be involved as soon as possible in the M&A process.
How Marsh can help
Since 2007, Marsh Asia PEMA team has helped many enterprises in the region manage their transaction risks with our advisory and brokerage services. With our well-established relationships with global carriers, our team can help clients assess, identify, and secure the appropriate level of tax liability insurance coverage during the M&A process, as well as provide timely claims advocacy and management services.