Tax Risk and Tax Insurance in M&A: In conversation with Dawn Bhoma (Icen Risk) 

The discussion ranges from the practical (what underwriters want to see when being asked to cover a risk) to the strategic, including how sophisticated buyers and sellers are increasingly deploying insurance at earlier stages of a transaction to remove deal friction and improve competitive positioning.

The podcast explores themes that are relevant to anyone involved in M&A transactions, including:

How Tax Insurance Operates in Practice

Tax insurance can be used both in Warranty & Indemnity (W&I) policies and for bespoke cover. It can prove especially useful in competitive bid situations to present a cleaner offer, avoiding 'price chips' and requests for specific indemnities. 

In the US market particularly, lenders now expect tax insurance to be included as a component of deals, with identified risks being either incorporated into a standard W&I policy or 'spun out' into standalone policies that can travel with the entity on future sales.

Routinely Insured Types of Tax Risk

Some risks would have been considered uninsurable a few years ago, but the market is increasingly varied now with common policies covering different types of risk including, for example, those relating to withholding tax, non-resident capital gains tax, debt deductibility, income versus capital characterisation, and a "real uptick in individuals " seeking to cover employment-related securities risks.

The market has, however, now evolved beyond purely technical risks to even encompass areas previously considered 'uninsurable'. Examples here include risks related to valuation risk, where underwriters now engage specialist valuation advisers to facilitate more expansive cover, and risks where clearance in advance from a fiscal authority has not been obtained.

Difficult or Impossible to Place Risks

Exposures that are already under enquiry or the subject of litigation can be placed but inevitably attract materially higher premiums. Despite market growth, Icen Risk still declines approximately half of the risks it receives. The main reason is territorial: a discomfort with a particular court system or the way a tax authority operates.

The second most common ground to refuse cover is a weakness in the technical position. Risks related to the G20/OECD Base Erosion and Profit Shifting (BEPS) Action Plan remain difficult to underwrite given their complexity, while Value Added Tax (VAT) risks in certain sectors can also create difficulty because of tax authority behaviour and because of evolving case law. Insuring in these areas is not impossible but obtaining cover will usually be dependent on the specific facts.

The Claims Process in Practice

The insurer's role is to operate 'behind the scenes' in a claim, reviewing proposed responses and information requests, but insurers will always need to understand the facts to provide the best available policy and support. 

Tax insurance policies are rarely (if ever) denied solely on the grounds of coverage because the bespoke nature of tax policies means the scope must be agreed clearly at inception. The market has also evolved to accommodate insureds that are required (or choose) to maintain an open dialogue with tax authorities, with insurers normally retaining a right to review disclosures before their submission.

Market Dynamics and Growth

The market is rapidly expanding geographically, with brokers establishing tax professionals across different jurisdictions, improving underwriting quality through local knowledge.

Corporates have emerged as significant buyers of cover for the first time in the last two to three years. This probably reflects insureds valuing certainty and the removal of risk, at an acceptable price point, in an environment where tax law is getting ever more complex.

The Future of Tax Insurance

Further significant growth in the tax insurance market is likely because of the evolution of tax legislation globally and because many clients have still not heard about the benefits of tax insurance. 

The emerging relevance of artificial intelligence (AI) in tax is also discussed, including how tax authorities are already using AI in ways likely to affect how they target audit activity, and how underwriters can deploy it as an efficiency tool.