Tax indemnity clause leads to friction among buyers & sellers of firms

The Centre had allowed the tax dept more time to relook at old transactions

Buyers and sellers of companies are clashing over how long they are willing to take responsibility for future tax liabilities, after the Centre allowed the tax department more time to relook at old transactions.
 
This has emerged as a headwind for private equity (PE) players, in particular. It comes amid a record number of PE-backed mergers and acquisitions (M&As) over the last two years. PE funds are essentially schemes, which take money from a number of rich investors and use it to buy large stakes in companies. Sometimes, they buy out the existing owner. Funds were doing as many as five such buyout transactions a week in 2019 and 2020, according to data from London Stock Exchange Group deal tracker Refinitiv. Both years marked a record in the number (281) of such transactions.
 
Discussions are said to have been heating up over how long a tax indemnity clause, which is part of such deals, should run, according to multiple people familiar with the matter.
 

People are unwilling to take responsibility for any liability for a tax scrutiny, which can take place 10 years after the deal.
 
"PE players are negotiating a middle ground, working out an indemnity for a period of seven years or so," said Bijal Ajinkya, Partner, Khaitan & Co. She added that it is easier for a strategic player to make such deals since they are not constrained by lifespan considerations.
 
Private equity funds often have a life of around five years that is extended by another two years or so, pointed out EY India financial services tax partner Anish Thacker. This would mean that a tax indemnity clause stretching to a decade would have to outlive the scheme.
 
"Fund lives are not that long," he said.
 
The tax department earlier had the power to look at transactions for a period of six years. This has been increased to 10 years in the latest Budget for transactions over Rs 50 lakh. The average buyout transaction in 2020 was worth over Rs 300 crore, shows an analysis of Refinitiv data.
 
The Budget actually announced that the reassessment window was brought down from six years to three years for all transactions.
 
Shares and securities are also considered assets. This means that when a private equity fund buys shares in a company in 2021, it could be subject to reassessment in 2031. The total value of buyout transactions was $12.8 billion in 2020 shows Refinitiv data. It was $25.5 billion in 2019. This translates into over Rs 2.5 trillion worth of deals over the last two years.
 
Tax insurance and escrow accounts are among the ways that people are looking to resolve the deadlock.