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Tax Insurance

InterpretationGap® offers coverage for loss incurred as the result of one or more tax positions or tax treatments being challenged and disallowed by the relevant tax authority. 

InterpretationGap® Tax Insurance can reduce or eliminate uncertainty relating to the outcome of one or more tax issues by providing reimbursement for financial loss incurred as a result of a successful challenge by the relevant tax authority.

The product can also be an effective complement to private letter rulings. As private letter rulings are issued in reliance upon representations made in the ruling request, an InterpretationGap® policy can provide a taxpayer with protection for certain representations that it has made in reliance upon statements made by a third party, such as the party that sold the asset or business at issue.

In addition, to further align the policy with the specific tax issue(s), InterpretationGap® Tax Insurance can be designed to:

  • cover the subject matter of a tax opinion or tax indemnity, although an opinion or indemnity is not required for the insurance to be put in place to provide coverage for the specific tax issue(s)
  • match the statute of limitations for the specific tax issue(s), up to 84 months. Longer policy terms may be available on a case-by-case basis.

InterpretationGap® is available for specific tax issues that arise in a taxpayer’s ordinary course of business, as well as for general pre-closing tax liabilities in connection with acquisitions.

InterpretationGap® Case Studies

The credit committee of a lender has approved all aspects of a loan to a company but has reserved final sign­off until it is satisfied that the crystallization of a potential tax exposure will not impair the company's ability to repay the loan. The potential tax exposure relates to the tax-free spin­off by the company of its office supply business. While the company has received a tax opinion from a reputable law firm that the spin­off should be tax­free, the analysis is a facts and circumstances analysis. As such, the lender is concerned that the IRS will unexpectedly contend that the business of the spun­off entity and the remaining business of the company should have simply been operated as two separate subsidiaries, and may determine that there is insufficient business purpose to support the tax­free spin­off. As a solution, an InterpretationGap® policy may be obtained by the company, with the lender as a “loss payee,” in the event the tax authority challenges the tax­free nature of the spin­off and the company cannot repay the loan.

A potential investor in a distressed company has identified the reclassification of a large number of independent contractors retained by the company as employees as a risk factor. While the company has several legal opinions concluding that its independent contractors are properly classified pursuant to the guidance given by tax authorities on the subject as well as case law, given the political climate, there remains a risk that an attempt will be made to reclassify the independent contractors as employees. The company will not be able to withstand the financial impact of such a re-characterization. As a condition to the investment in the company, an InterpretationGap® policy may be obtained by the company to respond in the event the tax authority challenges the classification of the company's independent contractors.

All intellectual property of a business is held in the subsidiary of the target company in an acquisition. The effective tax rate in the jurisdiction in which the subsidiary is domiciled is lower than that of the jurisdiction in which manufacturing subsidiaries that license much of the target company's intellectual property. Despite the fact that the target company has demonstrated a significant business purpose for the location of the subsidiary holding the licenses, as well as significant documentation relating to the similar licensing agreements entered into by unrelated third parties that would show that the terms of the licensing agreements are arm’s length, the buyer has concerns about the financial impact of a challenge by the relevant tax authority. In order to close the transaction, the seller may provide an indemnity to the buyer to respond in the event the tax authority challenges the tax treatment, and purchase an InterpretationGap® policy to protect itself from the tax exposure it has provided under the indemnity.

One of the largest shareholders of the target company in a proposed sale is a private equity fund. While the fund is willing to provide an indemnity for any exposure that is identified during the first 12 months after the transaction closes, the buyer requires an indemnity that survives for six years with respect to all pre­closing tax liabilities. Providing an indemnity of this size will prevent the private equity fund from proceeding with its planned liquidation soon after the 12-month anniversary of the close of the proposed transaction. As a solution, the buyer may obtain an InterpretationGap® policy to respond to any pre­closing tax liabilities of the target company.

The target company in a pending transaction started an assembly line in the middle of September 2001 and claimed bonus depreciation. The buyer was concerned that the assembly line may be found to have been “placed in service” prior to September 10, 2001. Such a determination would cause the seller to lose its ability to claim bonus depreciation, which in turn would mean that it significantly underpaid taxes in 2001. The seller is confident that it was entitled to claim bonus depreciation, and is unwilling to provide any security or hold­back in the event it is determined that bonus depreciation was incorrectly claimed. An InterpretationGap® policy may be purchased by the buyer to respond in the event the tax authority challenges the assembly line's placed-in-service date, allowing the transaction to close.

During the due diligence process for a pending acquisition of a target company which is the subsidiary of a large financially distressed company undergoing a restructuring, the potential buyer's tax advisor identifies a remote risk that net operating losses (NOLs) incurred by the company in years 2002 through 2006 could be limited as a result of a change in ownership. Tax advisors to both the proposed target company and the buyer agree that given the facts, the risk is low that the limitation on NOLs available to the target company following the transaction will be limited to a greater extent than if no change in ownership had occurred. However, due to the poor financial condition of the seller, a meaningful indemnification for the potential tax risk is not available. An InterpretationGap® policy may be purchased by the buyer to respond in the event the tax authority determines that the NOLs are limited as a result of a change in ownership, allowing the transaction to close.

The shareholders of an S Corporation target and the acquiring corporation agree to make a Section 338(h)(10) election whereby the stock sale is ignored for income tax purposes and treated as an asset sale instead. The buyer's tax advisors identified a risk that the target could fail to qualify as an S corporation as a result of certain circumstances which existed prior to the transaction (such as excessive salaries or perquisites to employee/shareholders or non­proportional dividends) that are deemed to have resulted in the issuance of a second class of stock. Tax advisors to both the target and buyer agree that given the facts, the risk of the Section 338(h)(10) election being successfully challenged is very low. However, neither the buyer nor the selling shareholders are willing to assume the risk. An InterpretationGap® policy may be purchased by the buyer to respond in the event the tax authority challenges the Section 338(h)(10) election, allowing the transaction to close.

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Frequently asked questions

Our InterpretationGap® policy can be offered to cover federal, state, and local tax exposures in the United States, as well as tax exposures arising in Canada, the European Union, Australia, New Zealand, and South Africa. Please contact us if you seek insurance for tax exposures in other jurisdictions.

While a tax opinion is helpful, it is not required. A memorandum setting out the fact pattern associated with an analysis of the tax exposure by a professional tax advisor will generally provide us with adequate information to provide you with preliminary terms.

Yes. We sometimes offer InterpretationGap® Tax Insurance in situations where a taxpayer’s auditors require that reserves be posted despite agreeing that the practical risk of a tax liability ultimately crystalizing is unlikely.

“Loss” can include the taxes associated with the insured tax exposure, interest on those taxes, gross-up, and in some jurisdictions, civil penalties where they are insurable by law.

As part of the underwriting process, Ambridge will request a description of how the requested limits have been calculated. This should be prepared by the insured together with its tax advisor.

Generally, we can provide preliminary terms within 24 to 48 hours. Completion of full underwriting is dependent upon how quickly detailed information is provided to Ambridge. Ambridge frequently can offer bindable terms within several days after receipt of the initial submission.

We can be most responsive to your request if you are able to provide:

- a description of the tax exposure for which insurance is desired

- an outline of all facts that the potential insured’s tax advisors believe are relevant to analyzing the exposure

- a calculation of the quantum of the potential tax exposure, the amount of insurance requested, and the reason(s) for requesting that amount of insurance

- confirmation that the tax exposure is not associated with a tax shelter, “reportable transaction”, or “transaction of interest”

- any analysis done by a professional tax advisor

No. Ambridge does not underwrite any insurance product in connection with taxes, interest, or penalties that may be incurred with respect to any “reportable transaction” within the meaning of Treasury Regulation section 1.6011-4(b).

No. Ambridge’s InterpretationGap® Tax Insurance product is only offered in connection with tax exposures where a taxpayer’s filing position is consistent with what it believes to be proper based upon advice from tax advisors.