CHAPTER SEVENTEEN COUNTER COVENANT 10.1 The Buyer hereby covenants with the Covenantors to pay to the Covenantors by way of adjustment to the Consideration, an amount equal to any Tax Liability for which the Company is liable but for which the Covenantors become liable as a result of the failure by the Company to discharge it. Executive Summary A B C D The counter-indemnity or undertaking to pay given by the Buyer to the Sellers is now virtually standard. There is a growing number of sections in the taxing statutes which may require someone other than the taxpaying entity to settle tax if it is not settled by that entity. These sections create risks for both the Buyer and the Sellers. Payments made by the Buyer to the Sellers in the form of additional consideration will be likely to crystallise tax charges on the Sellers and a grossing up clause is therefore required. It is difficult to place any construction on payments made by the Buyer to the Covenantors other than that they represent, for tax purposes, additional consideration for the shares in the Company. 164
1 Introduction 1.1 There are various circumstances in which Sellers will seek an indemnity from the Buyer in respect of tax liabilities. Requests for such indemnities are now virtually standard, and are not usually resisted. There is protection to the Buyer in the standard Tax Covenant in that the Buyer is protected from unforeseen taxation which is the primary or secondary liability of the Company. There is however, some scope for tax to splash back to the Seller, and an indemnity from the Buyer may therefore be appropriate. 1.2 There are several specific circumstances to consider when considering indemnities from the Buyer: 1.2.1 the risk of the Sellers having to meet certain liabilities to taxation, if there is default by the Buyer or the Company; 1.2.2 the risk of the Buyer being able to make a claim under the Tax Covenant, even though the tax originates in the Buyer s group but is, as a question of fact, paid by the Company and relates to an event before Completion but within the Buyer group; 1.2.3 the risk associated with liabilities which may settle on the Company following a further sale of the Company by the Buyer after Completion. 1.3 Some of these risks may be seen as remote. However, it is understandable, in view of the power of a Tax Covenant, that professional advisers acting for the Sellers normally want to obtain the comfort of a Covenant from the Buyers in these circumstances. 1.4 The above counter-covenant wording covers the risks in 1.2.1 and 1.2.3 only. Protection against the risk in 1.2.2 has to be obtained from an extension of the above wording, or from one of the exclusion paragraphs. 1.5 In order to identify the need for the counter-covenant we are therefore exploring below some of those provisions within the taxing statutes which may be relevant. 2 Sections 706-712 CTA 2010 (formerly Section 767A, ICTA) 2.1 A counter-covenant in respect of Sections 706-712 CTA 2010 is now very close to being a standard term: the irony is that it is only likely to apply if some very peculiar circumstances of the Company or any subsidiaries apply prior to Completion. The tenacious insistence that protection against Sections 706-712 should be included belies this simple point. 2.2 These sections deal with corporation tax liabilities on a change in company ownership. They provide that where there has been a change of ownership of a company and any corporation tax in respect of a period before the change of ownership remains unpaid, then the tax in question, in certain very narrow circumstances, may be charged to the Seller. 165
2.3 This Section is an anti-avoidance section: the mischief was that a trade of a company was transferred out, possibly to a group company. The company which had previously been active was then inactive and was left with cash sufficient to meet its final tax liability. The shares in the company were then sold to a non-resident company for consideration equivalent to a proportion of the cash on the balance sheet. The company did not meet the tax liability and, without the protection of Sections 706-718 CTA 2010, there was no recourse available for the UK tax authorities. 2.4 The only Seller who can be charged is the Seller who controlled the Company. However, the usual definition of control in Sections 450-451 CTA 2010 (formerly Section 416 ICTA) is modified by Section 707(3) to (5) CTA 2010 so that it embraces shareholders with a 50% share holding and also embraces two or more persons if they are acting together. The Seller or Sellers can be personally charged, as can any other company that they control (Section 706(3) CTA 2010). 2.5 Sections 706-712 do not provide a complete lifting of the corporate veil, as the tax can only be charged to the Seller if any of three stated conditions are met (Section 711 CTA 2010). 2.6 The first condition is that at any time during the period of three years before the change in the ownership of the Company the trading or business activities of that company ceased or virtually ceased, without a significant revival taking place (Section 711(2) CTA 2010). 2.7 The second condition is that the cessation of the trading or business activities took place after the change of ownership but in accordance with arrangements in place before such change (Section 711(3) CTA 2010). 2.8 The third condition is more complex: if there is a major change in the nature or conduct of the trade in the 6 year period beginning three years before Completion, there is a transfer of assets out of the Company to the Seller or anyone connected with him, and the major change is attributable to that asset transfer (Section 711(4) CTA 2010). 2.9 The three conditions all relate to actions of the Seller and it is difficult to see why there should be any counter-indemnity provided by the Buyer, unless the Company being bought has become virtually dormant and has outstanding corporate tax liabilities. 2.10 There is a set of circumstances which may appear to lead to an exposure for the Seller: if the Buyer carries out any steps which are within the three conditions, and then sells the Company to another party within three years, then, at first sight, those persons who are liable are any person who controlled the Company in the previous three years. However, Section 709(3) provides that the period of three years is shortened if there are two changes of ownership as described above. If there are two changes of ownership, the Seller at risk is the Seller in the second transaction. 166
2.11 It therefore appears that the situations in which a Buyer s indemnity should be provided to the Seller in respect of Sections 706-712 CTA 2010 are only those in which the Company or a subsidiary has become dormant or virtually dormant prior to Completion and there are outstanding corporation tax liabilities. These very peculiar circumstances can then be changed by the Sellers ensuring that any such tax liabilities are settled prior to Completion, as this would not affect the level of the group net assets. 2.12 Section 717(2) provides that any person making a payment under Sections 706-718 shall be entitled to recover an amount equal to the payment from the relevant company. Such recovery is of tax that has been paid by such person. There must be doubts as to the nature of such recompense for tax purposes, but HMRC have confirmed that a payment by the Company to reimburse the Seller is not taxable on the Seller. A payment expressed to be additional consideration paid by the Buyer to the Sellers is likely to be taxable unless the substantial shareholdings exemption, or some other exemption applies. 3 Sections 713-715 CTA 2010 (formerly Section 767AA, ICTA) 3.1 These sections are based on the concept of a reasonable inference that the change of ownership of the Company was linked to an expectation by the Buyer or the Seller that the tax liabilities would not be met in full (Section 714 CTA 2010). 3.2 In contrast to Sections 706-712, these sections are dealing with corporation tax in respect of accounting periods ending on or after the change of control. The Sellers potentially caught are the same as in Sections 706 to 712 above. 3.3 This is also an anti-avoidance section: as a variation on the scheme blocked by Sections 706-712, tax liabilities were held over or rolled over, so that they crystallised after the change of ownership had taken place. 3.4 The scope of Sections 713-715 is wider and more uncertain, as it depends on what is a reasonable inference. The strict interpretation of the Section would indicate that an entirely innocent Seller could be liable for unpaid corporation tax if the Buyer entered into the transaction on the assumption that the liability to future corporation tax was unlikely to be met. 3.5 A counter-covenant with regard to Sections 713-715 CTA 2010 is therefore an appropriate feature of a Tax Covenant. 3.6 As noted above, any person making a payment under these sections shall be entitled to recover an amount equal to the payment from the relevant company. 4 Sections 109B-109F Taxes Management Act 1970 (formerly Section 132, Finance Act 1988) 4.1 This deals with unpaid corporation tax in respect of migrating companies, that is companies which cease to be resident in the United Kingdom. The period at risk is the 12 months ending with the date when the Company ceases to be resident in the United Kingdom. 167
4.2 There are two classes of entities caught by this section: firstly any company which was in the same group as the migrating company in the 12 months up to the point of migration is within charge; secondly any person who was a director of the migrating company in this same period and had control of it is also subject to the charge. 4.3 These sections enable HMRC to recover the unpaid corporation tax from either the group member or the controlling director referred to in paragraph 5.2 above. 4.4 It is therefore possible for a corporate or individual Seller to find himself within the charge if the Buyer arranges for the migration of the Company within 12 months of Completion, leaving corporation tax unpaid. 4.5 Any person who pays tax under Section 109E(4) may recover any such amount paid by him from the migrating company. 5 Section 139, TCGA 1992 5.1 This section deals with reconstructions involving a transfer of a business from one company to another. As an example, certain types of demerger involve the use of this section. 5.2 The section is generally an enabling section: it allows for the transfers of assets to be made without a chargeable gain arising, provided that the reconstruction is being carried out for bona fide commercial reasons and does not have, as its main purpose, the avoidance of tax. 5.3 Tax on chargeable gains therefore arises under this section when the conditions within it are not met. This arises, broadly speaking, if any of the companies involved are not resident in the United Kingdom, or if the reconstruction is not carried out for bona fide commercial reasons. 5.4 Section 139(7), TCGA, provides a circumstance when the Seller may be liable for tax: if the transaction is not protected by the exemption in this Section, the tax on chargeable gains would normally be payable by the transferring company. However, if the tax is not paid by the transferring company, the tax can be charged to any of the companies who received the assets in question. They may either receive the assets directly, or indirectly as part of an intra-group transfer. 5.5 This section should therefore be included as a Buyer s covenant in the circumstances when the Seller Company has received assets in a non-qualifying reconstruction from the Company prior to Completion and the tax remains unsettled by the Company at Completion. 5.6 It is more likely that the Seller requires protection in respect of transactions which take place within the Buyer group: if the Buyer has carried out a reconstruction prior to Completion it is possible that the Company may become indirectly liable in due course. As the terms of the main Covenant will include tax payable directly and indirectly by the Company arising in respect of events prior to Completion, there is an effective need to carve out liabilities arising from secondary tax in respect of the Buyer group. 168
5.7 This protection is normally included as an exclusion in respect of Tax which arises in the Buyer s Group, and this is covered in 3.1.16 of the sample covenant in chapter 5. If the exclusion in paragraph 3.1.16 is narrowed so that it is focused only on the single issue of the small companies rate of corporation tax it is important that the counter-covenant is broadened to protect the Sellers from tax which originates in the Buyer s group but is not settled by them. Otherwise the wording of a standard covenant could, quite unwittingly enable the Buyer to make a claim for such Taxation from the Sellers. 5.8 Section 139(7) provides that any person paying any tax under this section shall be entitled to recover from the chargeable company a sum equal to the tax paid together with any interest paid by him. 6 Section 189, Taxation of Chargeable Gains Act 1992 6.1 Section 189, TCGA deals with capital distributions: these are defined in Section 122, TCGA as any distribution, including a distribution in a winding up or dissolution in money or money s worth, but excluding any distributions which are treated as income in the hands of the recipient. 6.2 If a shareholder receives a capital distribution he may be assessed to the tax on the underlying chargeable gains made by the company, if the company does not settle the tax in question. The shareholders at risk are those who control the company on their own, or in conjunction with people connected with them, or shareholders who control a company by virtue of acting together. 6.3 As an example, Mr and Mrs White own the entire share capital of Rishangles Triangle Limited; they use informal winding up procedures together with the concessionary treatment set out in Extra-Statutory Concession C16. The first property owned by the company is distributed to Mr and Mrs White as a capital distribution in specie. In addition to this they receive 250,000 in cash as a further capital distribution, representing the disposal proceeds from the second property owned by the company. Under the provisions of Section 189, they will be liable for the tax owing by the company on the disposal of both the first property and the second property to the extent that the tax is not settled by the company. 6.4 Further examples of capital distributions are shares or assets transferred in a demerger, or in a Section 110, Insolvency Act, Reconstruction. It is therefore possible for shares to be sold in a company which has been the recipient of such capital distributions. The Buyer may consider that it needs protection from Section 189 tax as the Company may have received a capital distribution shortly before Completion. If the corporate Seller does not settle the tax on the disposals of the capital assets, this tax can be collected from the Company. 6.5 The circumstances in which the Sellers may need protection are if some form of reconstruction is undertaken shortly before Completion, with some assets being distributed to the Sellers. If the Company then fails to pay the tax on the chargeable gain, such tax will be payable by the Sellers. 6.6 Section 189(4) uses virtually the same wording as used in Section 139(7) as described above in respect of entitlement to recovery. 169
7 Section 190, Taxation of Chargeable Gains Act 1992 7.1 This section provides for tax on chargeable gains to be recovered from another group company or from a controlling director in certain circumstances. 7.2 If the company which is primarily chargeable to the corporation tax on the chargeable gain fails to pay, the principal company of the group at the time of the disposal, or any other company in the group which owned the asset in the 12 months prior to the date of the chargeable disposal, can be required to pay the tax. 7.3 If the tax is primarily payable by a non-uk company which has a permanent establishment in the UK, any controlling director can be made to pay the tax. A controlling director is a person who is a director and controls it, using the normal control tests as set out in Sections 449-452 CTA 2010. 7.4 Both the Buyer and the Sellers need protection in respect of this potential liability: 7.4.1 the Company may have owned a chargeable asset which was transferred to another company in the Seller group shortly before Completion. If tax on a further disposal within the next 12 months is not paid, that tax can be visited on the Company; 7.4.2 the Company may have disposed of a chargeable asset and the Completion Accounts may include an appropriate provision for the tax on the chargeable gain. If the Buyer does not procure the payment of that tax, then it is payable by the principal company in the Seller group, or any other group member which previously owned the asset. 7.5 Section 190(11) reads: A person who has paid an amount in pursuance of a notice under this section may recover that amount from the taxpayer company. Unlike Sections 139 and 189 there is no express reference to interest charged under the Taxes Management Act, but such interest must presumably be considered as included in the above wording. 8 Section 282, TCGA 8.1 If a capital asset is transferred by gift, the normal CGT rules are that the transfer is deemed to take place at market value (Section 17, TCGA). There is the prospect of gifts on trading assets being held over. Otherwise, the making of a gift can trigger a capital gains tax charge on the donor. 8.2 If the donor fails to pay the tax in question, it may be assessed on the donee under Section 282. 8.3 Section 282(2) TCGA provides that a person paying an amount of tax in pursuance of this section shall be entitled to recover a sum of that amount from the donor. It is therefore clear that this does not make allowance for the recovery of interest charged under the TMA, unlike the previous sections. 8.4 Gifts into companies are surprisingly common but normally in respect of trading assets for which a holdover election can be made: an unincorporated business will often be transferred into a limited company using the provisions of Section 165, TCGA. This provides for the excess of the value over the consideration paid to be held over. 170
8.5 As an example, Earl Soham IT Consultants is a very profitable partnership of Mr Green and Mr Black. They transfer the assets and undertaking into a limited company expressly set up for the purpose, with the inspired name of Earl Soham IT Consultants Limited. The goodwill is transferred into the company at a value of 50,000, whereas it is considered to have a value of 250,000. The gain that would otherwise arise under the provisions of Section 17 TCGA is held over under the provisions of Section 165, TCGA. They also transfer into the limited company two properties: the first property is occupied by the business and the second property is the next door property, which is rented out to the village butcher. Each property has a value of 300,000 but each is transferred into the limited company at its original cost to the partners of 50,000. The two partners are wrongly advised and believe that the gains on both properties can be held over. In fact the gain on the second premises cannot be held over. If they fail to pay the capital gains tax that crystallises on the second property, the tax can be assessed on the Company. 9 Sections 973-980 CTA 2010 (formerly Schedule 28, Finance Act 2000) 9.1 This relates to UK tax payable by a non-resident company, which is not paid by that company. 9.2 The companies which may be required to pay the tax in question are any company in the same group as the defaulting company, any member of a consortium owning the defaulting company and any company in the same 51% group as any consortium member. These conditions have to be met at some time in the relevant period. 9.3 The relevant period is the period from 12 months before the start of the relevant accounting period to the date when the tax is payable. Therefore, if the accounting period is for 12 months, the relevant period will be a total of 2 years, 9 months. 9.4 In what circumstances does the Seller require protection from the impact of this contingent liability? Clearly if the Company is non-resident then protection is needed in the form of a Covenant from the Buyer. In these circumstances, if the Buyer does not procure that the Company settles its tax liabilities falling due after Completion, the tax can be charged by HMRC to the Seller. The same applies if the Company owns a group or consortium interest in the non-resident company. 9.5 Whether the protection set out in 9.4 above is needed or not will depend on the peculiar circumstances of the Company at the time of Completion and this will clearly be known to the Seller. 9.6 There is a broader risk to the Seller, which extends beyond these peculiar circumstances: the Company may be liable to pay tax in respect of a non-resident company which is a member of the Buyer s group. If the tax relates to transactions taking place before Completion, then the main covenant will make the Seller potentially liable. 9.7 Section 980(1) includes the hallowed words that a company that has paid an amount in pursuance of a notice under this Chapter may recover that amount from the taxpayer company. 171
10 Section 43 and Sections 43A to 43D, Valued Added Tax Act 1994 10.1 Section 43, VATA 1994, provides for bodies corporate to be treated as members of a group, in which case any business carried on shall be treated as carried on by the representative member. All members of the group shall be liable jointly and severally for any VAT due from the representative member (Section 43(1), VATA 1994). 10.2 The alternative conditions set out in Section 43A, VATA 1994 for creating such a group are that: 10.2.1 one of the bodies corporate controls each of the others; 10.2.2 one person (whether a body corporate or an individual) or a business partnership controls all of them. 10.3 The existence of the joint and several liabilities can create problems with VAT if the Company is a member of a VAT group prior to Completion. It is very likely that the Company will record its VAT recoverable and payable in respect of the transactions that it makes with entities outside the VAT group. There will then be a VAT liability or asset at Completion, representing the net VAT effect. As long as the VAT group remained in being, a single return would be made by the representative member and the balances on the VAT account would be transferred by means of an intercompany transfer to the representative member. 10.4 If the Company is in a VAT group and if there is a liability in the balance sheet of the Company at Completion, then there is a risk to the Sellers in respect of this liability: if the Buyer does not procure the payment of the VAT that arises for the period up to the point of Completion, then the liability falls on the Seller group. 10.5 An indemnity from the Buyer is therefore appropriate in the circumstances of a corporate Seller, if the Company has been part of a VAT group with other companies in the corporate Seller s group. 10.6 In addition to this, if the Company is made a member of the Buyer s VAT group after Completion, it is then jointly and severally liable for any VAT payable to HMRC in respect of that group. This may cover VAT on transactions arising up to Completion and this may therefore result in the Buyer being able to claim for such VAT costs under the Tax Covenant. 11 Other Valued Added Tax Contingent Liabilities 11.1 There are several other circumstances in which VAT can be assessed on a company other than the company with the primary liability: these mainly relate to activities such as missing trader or carousel fraud. Due to the unusual nature of these liabilities, it would not normally be necessary to refer to them specifically in any Covenant from the Buyer. 172
12 Stamp Duty: Section 111 and Schedule 34, Finance Act 2002 - Withdrawal of Group Relief 12.1 Property can be transferred within 75% groups without there being an immediate charge to Stamp Duty Land Tax, due to the operation of group relief (Section 42 (2B), Finance Act, 1930). Under Section 111, Finance 2002, group relief is withdrawn if the company receiving the property leaves the group within three years of the transfer, if it still holds the property in question, and if it effectively separates from the transferor company. 12.2 The primary liability falls on the transferee company which is leaving the group. (This is therefore similar, in some ways, to the charge that arises on the transferee company under the provisions of Section 179, TCGA.) 12.3 Under Paragraph 8(2) of Schedule 34, Finance Act 2002, if the company with the primary liability does not pay the Stamp Duty, the liability can be charged, broadly speaking, to the following: 12.3.1 the transferor company; 12.3.2 any company which was, at the relevant time, above it in the group structure; 12.3.3 any person who, at the relevant time, was a controlling director of the transferee company or of a company having control of the transferee company. 12.4 The relevant time is any time between the date of transfer and the transferee leaving the transferor group (Paragraph 8(3)(a), Schedule 34, Finance Act 2002). 12.5 A company is above another company in the group structure if it is the parent of the transferee company or the parent of another company that is above that company in the group structure (Paragraph 8(3)(b), Schedule 34, Finance Act 2002). 12.6 The Buyer protections in the Tax Covenant are normally given under the provision which includes all taxation payable by the Company: the Tax Covenant will be worded so that the Seller is liable for tax liabilities of the Company, whether the Company has the primary or the secondary liability. 12.7 The Seller needs protection if such a transfer of property has taken place into the Company prior to Completion and the stamp duty payable has been provided for but not paid. (Alternatively, the Seller could arrange for the tax in question to be paid to HM Revenue and Customs prior to completion.) 12.8 At first sight there is not the same need for protection from a secondary liability: if the Buyer s group had made a transfer of a property to a subsidiary in the three years prior to Completion, and if that subsidiary had then left the Buyer s group after the transfer, but prior to Completion, the Company would not be amongst the persons with a potential liability as referred to in Paragraph 8(2) Schedule 34, Finance Act 2002. 173
12.9 There is however a circumstance in which the Company could be liable under Section 111, Finance Act 2002: if the Buyer s group has made an intra-group property transfer in the three years up to Completion, and the Company is inserted into the Buyer s group above the transferee company, then there could be a secondary liability on the Company if the transferee company left the Buyer s group after Completion. The Company would be above the transferee company in the Buyer s group in the relevant period and it is arguable that the stamp duty in question can be attributed to the transfer of the property to the transferee, rather than to the transferee leaving the Buyer s group. If such, the Event happened before Completion, and there is a secondary liability on the Company which would be caught by the standard Tax Covenant. 12.10 Due to the risk referred to in Section 12.9 above, it is wise to include reference to this as an Indemnity from the Buyer - this then stops the Buyer from making a claim under the Tax Covenant in such a circumstance. 13 Stamp Duty: Section 113, and Schedule 35, Finance Act 2002 - Withdrawal of Relief for Company Acquisitions 13.1 Section 76, Finance Act 1986 offers relief if a company acquires the whole or part of an undertaking of another company ( the acquiring company ) in exchange for shares. A classic situation in which this relief may be appropriate is a demerger using the provisions of Section 213(3)(b)(i), ICTA 1988. 13.2 If the conditions of Section 76 are met, then the rate of stamp duty is limited to 0.5%. If the assets transferred include land, this is likely to be a lower rate than the ad valorem stamp duty rate that would apply. 13.3 Under the provisions of Section 113, Finance Act 2002, if control of the acquiring company changes in the three years after the transfer, and the land is still held within the acquiring company or a subsidiary, then ad valorem stamp duty is payable (Section 113(1), Finance Act 2002.). There are certain exceptions to this, as set out in Paragraph 2 and 3 of Schedule 35, Finance Act 2002. 13.4 Under Paragraph 9(2) of Schedule 35, Finance Act 2002, the following persons may be required to pay the Section 113 tax if it is not paid by the acquiring company: 13.4.1 any company that at any relevant time was a member of the same group as the acquiring company and was above it in the group structure; 13.4.2 any person who at any relevant time was a controlling director of the acquiring company or of a company having control of the acquiring company. 13.5 The same definitions apply as in section 12 above with regard to the relevant time and above. 13.6 There is therefore the same risk to the Sellers if the Buyer s group has had the benefit of relief under Section 76, Finance Act 1986 in the three years up to Completion. If the Company is inserted into the Buyer s group above the acquiring company, there is a secondary exposure arising from Paragraph 9 (2), Finance Act 2002. 174
14 Inclusion of Other Seller Protections 10.2 The provisions of clause 4 (due date for payment), clause 5 (deduction from payments) and clause 6 (claims) shall apply to this clause as if the same were set out herein but substituting references to the Covenantors with the Buyer (and vice versa) and making any other necessary modifications. 14.1 As this is an undertaking to pay, but given by the Buyer to the Seller, there are various matters that need to be covered in order to give some certainty. It makes sense to use the existing clauses, designed to deal with the main covenant, for this purpose. 14.2 Clause 5 deals not only with deductions from payments but also grossing up: as the payment by the Buyer to the Sellers is stated to be additional consideration for the sale shares this clause may be needed: if the Seller is a trading company the substantial shareholdings exemption may have applied, with the result that there was no tax payable on the gain on the disposal of the shares. In other cases there will be tax payable, and the Sellers may therefore need the protection of the grossing up clause. The complexity here can be demonstrated by an example: 14.2.1 Mickfield Holdings Limited is an investment company which owned Mickfield Distribution Limited; it sold its shares for aggregate consideration of 5 million. The base cost of the shares was insignificant. The gain in Mickfield Holdings Limited was taxable at a rate of 28% as the substantial shareholdings exemption did not apply. Mickfield Holdings Limited was then required to pay tax of 500,000 due to a failure by the Buyer to procure payment of a tax liability by the Company. This arose under the provisions of Section 190, TCGA. The payment was stated in the Tax Covenant to be additional consideration for the shares. It was therefore required to pay tax on this payment by the Buyer. The grossing up clause was therefore invoked, with the consequence that the total sum payable by the Buyer was 694,444. This increased the base cost of the shares in the hands of the Buyer by that amount. However, under the provisions of Section 190(11), TCGA, Mickfield Holdings Limited was able to recover the tax from the Company. If the Buyer had instead procured that the tax was paid to Mickfield Holdings Limited by Mickfield Distribution Limited, then the amount that would have been payable would have been 500,000. 15 Exclusion to Counter-Covenant 10.3 The covenant contained in clause 10.1 shall not apply to a Tax Liability to the extent that the Covenantors are liable to make or have made a payment in respect of that Tax Liability under clause 2 of this Tax Covenant. 15.1 This clause should not be accepted unless an appropriate exclusion is also included in the covenant: as has been shown above, there are some instances where a secondary tax liability can be visited on the Company from the Buyer s Group, in respect of a transaction before Completion. There are therefore two ways in which the Sellers can gain protection from such Tax Liabilities being covered by the undertaking to pay: 15.1.1 an exclusion can be accepted so as to exclude from the coverage of the Tax Covenant any Tax Liability originating from the Buyer s Group, excepting the Company; or 15.1.2 the above clause is modified or deleted. 175
15.2 It is completely understandable that the Buyer wishes to exclude from the countercovenant any tax which would have been a liability of the Covenantors if the Company had made the payment. However the breadth of this wording does take away the protection for the Covenantors from those tax liabilities which have originated in the Buyer s Group, and should therefore never, in all conscience, have been a liability of the Covenantors under the Tax Covenant in any event. 16 Discharge of Tax 10.4 Any payment made by the Buyer to the Covenantors under this clause 10 shall be applied to discharge the Tax Liability giving rise to the claim under this clause 10. The Covenantors shall not enforce any statutory right of recovery against the Buyer in respect of a Tax Liability to the extent that it has already made a recovery in respect of that liability under any statutory right or otherwise. 16.1 The statutory rights of recovery arise under the various tax provisions which have been detailed above. Therefore this clause is to ensure that the Covenantors are not entitled to recover under the covenant to pay and also under their statutory rights. The case of Mickfield Holdings Limited is in point (14.2.1). 17 The Tax Treatment of Payments under the Counter-Covenant 17.1 The wording at the start of this chapter refers to payments under the countercovenant being by way of adjustment to the consideration. As the payments are made by the Buyer to the Covenantors, it is difficult to place any tax construction on the amounts except that they represent additional consideration for the shares. 17.2 If the amounts are due from and payable by the Company to the Covenantors, then a different construction then applies, providing that the Company is a party to the Tax Covenant and not merely the paying agent for the Buyer. In this situation the Company has made a payment which is probably a capital payment for the purposes of tax on chargeable gains. There is no asset acquired and it seems that this payment would create a capital loss in the Company. 17.3 The Covenantors have received a sum in respect of the disposal of their shares in the Company. This sum will be taxable on them. 176