Authors: Joyce Koch Vera Dembski
Companies are increasingly utilising tax liability insurance (TLI) as a strategic tool to navigate complex tax positions, maintain financial agility, and ensure compliance, effectively mitigating risk in today's challenging regulatory environment.
Understanding tax liability insurance
TLI is a risk-mitigation solution designed to address tax liabilities stemming from technical or regulatory unclarities. It can cover both historical and future tax exposures caused by a gap in tax law or legislation interpretation, however, it will not offset any loss from routine filing errors or support aggressive tax strategies.
Coverage
A well-structured TLI coverage protects against tax risks including late-payment interests, non-punitive penalties and defence costs, regardless of the eventual outcome of the challenge. Furthermore, the policy can include gross-up provisions, ensuring that any tax imposed on an insurance payout is itself treated as a covered loss. In effect, TLI transfers insurable tax risks from the client's balance sheet to the insurer's. By doing so, TLI offers financial certainty in complex transactions and prevents the need to lock up funds for a longer period of time.
Insurable tax risks
TLI applies to a range of scenarios involving interpretational discrepancies that may lead to potential tax exposures. While often used in mergers and acquisitions, TLI is now being applied more broadly across business scenarios such as internal reorganisations, debt restructuring, operational decisions and even transfer pricing policies — especially for liabilities extending beyond the taxpayers' home jurisdiction. Other areas where TLIs can offer substantial protection are:
- Winding-up of funds
- Risks related to tax assets, like carried-forward losses, capital allowances and R&D or tax credits
- Individual tax exposures involving relief qualification and income characterisation
- Where there is uncertainty over the eligibility for exemptions
- In case of active or pending tax litigation
- (Independent) Contractor classification
- Questions arising around permanent establishments in cross-border operations
Standard exclusions
TLI provides a broader coverage profile when compared to contemporary policies such as warranty and indemnity insurance, which carry a long list of exclusions. Its only standard exclusion is changes in law; TLIs cannot be used to hedge against future legislative changes or shifts in tax legislation. However, re-interpretations of existing law either by lower of Supreme Courts and even European Court of Justice remain covered and protected.
“Companies need to consider taking positions in tax filings. For example, VAT requires real-time decisions, while other tax positions often lack clear legal guidance, forcing businesses to rely on the best available arguments. However, tax authorities can reassess these positions years later, using new jurisprudence or developments for different interpretations, and levy taxes that subsequently lead to disputes. Tax liability insurance helps balance this disparity, supporting businesses in navigating such complex tax risks.”
- Joyce Koch, Senior Tax Broker, Gallagher
The benefits of tax liability insurance
Beyond risk mitigation, TLI provides a strategic advantage that can streamline transactions, enhance financial agility and boost capital efficiency. Here's how TLI can support your broader business objectives:
- Replaces ambiguity with a clearly structured insurance solution, reducing exposure to defence costs from potential disputes or surprise tax liabilities
- Allows tax exposures to be isolated and insured outside the core negotiation, making exits and acquisitions smoother
- Ensures unresolved tax concerns are ring-fenced and insured, thus eliminating the need to withhold funds or renegotiate terms due to unresolved tax concerns
- Provides a competitive edge in bids and auctions by demonstrating financial certainty to sellers and clients
- Substantiates financial stability when looking for debt funding
- Enables the release funds and the unwinding of contingent plans that were previously earmarked for potential tax liabilities, providing for reinvestment in other areas
Understanding the underwriting process: Key factors of tax liability insurance
As a bespoke solution, TLI relies on clear, well-documented information to assess the insurability of a risk. So, when seeking coverage, it is essential to procure a written overview of the tax exposure — ideally, a tax or legal memo prepared by an advisor that outlines the relevant facts and circumstances, the tax position taken or to be taken, the basis for uncertainty and the supporting rationale.
“When advising a client considering tax liability insurance, we recommend thorough due diligence and risk assessment that ensures the risk is accurately identified and quantified. This can secure better terms, attract stronger market interest and lead to potential savings on premiums, ultimately providing financial benefits for the clients.”
- Vera Dembski, Tax Broker, Gallagher
Along with the tax position credibility analysis, the following factors will also influence the underwriting process and help determine your coverage viability.
- Limit of coverage: TLIs often have a limit of liability, with cover ranging from EUR 700,000 to over EUR 1.2 billion
- Price premiums: Pricing depends on the complexity of the tax position and its related jurisdictional sensitivity. Typically, premiums are one-off upfront payments, with rates for EU and EEA typically ranging from 1% to 4% of the limit of liability purchased
- Policy period: The standard policy period is seven years, extendable to ten years in certain circumstances
- Underwriting process: The TLI placement process starts off with an initial call with the broker, followed by submission of the tax position documentation for review. The entire process typically takes 10-25 business days (can in case of urgency, be as fast as a few business days), provided all relevant information is supplied in a timely manner
Gallagher's strategic approach
As the landscape of tax risk continues to evolve, tax liability insurance has shifted from being a reactive safeguard in an M&A transaction to becoming a proactive enabler of strategic decision-making.
Our tax specialists at Gallagher leverage decades of global tax and insurance experience to craft customised tax insurance solutions tailored specifically to your needs.
If you have any queries about your business tax exposure, reach out to our tax advisors to have a discussion with no business obligation.
