Dodika Limited, Gedala Limited, Login Establishment, Laytonera Limited, Ninaz Limited, Romih Limited, Tarmea7 Limited, Zetta IQ Limited v United Luck Group Holdings Limited [2020] EWHC 2101 (Comm)
Generally speaking, although there are exceptions, a company is responsible for its own tax liabilities regardless of who owns it.
A buyer purchasing a company therefore risks having to foot the bill for hidden or unknown tax liabilities incurred before its ownership. A tax covenant will typically require the sellers to indemnify the buyer for any tax liabilities which arise after completion of the sale but relate to the period prior to it. The indemnity might be incorporated into a schedule of the sale and purchase agreement itself or provided for in a separate deed.
Tax covenants can be quite complex and are fairly bespoke to each transaction, as the tax status and liabilities of each company will be different. In the UK, HM Revenue and Customs may review the tax affairs of a company and claim any unpaid tax for the preceding seven years (or longer in certain circumstances). This long period of review is the reason tax covenants need to be carefully drafted as the financial consequences can be severe if there are historic tax issues or liabilities.
Whilst a tax covenant provides protection for the buyer, the sellers will usually negotiate a set of limitations to provide them with some certainty as to the extent of their financial liability, the time period in which a claim may be made and the process the buyer has to follow if it wishes to make a claim. Procedural requirements can include whether the claim needs to be in writing and what information the notice needs to include.
A recent case has highlighted the importance of strict compliance with the notice requirements set out in the sale and purchase agreement otherwise the buyer risks their claim being invalid. The buyer in this case purchased the holding company of a group specialising in mobile device applications from around 200 sellers. The transaction was worth around $1 billion… so not a small transaction.
A year and a half after completion of the purchase, the Slovenian tax authority launched an investigation into the tax affairs of the group. Part of the purchase price was still held in escrow when the investigation started and to avoid it being paid out to the sellers, until the investigation was over, the buyer issued a notice of claim under the tax covenant. The notice explained that there was an ongoing investigation and even provided a timeline of events but it did not go into detail about what was being specifically investigated.
Under the sale and purchase agreement, the buyer was required to set out in the notice "in reasonable detail the matter which [gave] rise to such Claim, the nature of such Claim and (so far as reasonably practical) the amount claimed".
The court held that the notice did not give details of the "matter giving rise to the Claim". Whilst the notice referenced the investigation by the Slovenian tax authority, this was not the matter giving rise to the claim. The matter giving rise to the claim was the underlying "facts, events and circumstances" being investigated and on which the buyer was relying in support of its claim. Therefore, because the notice had failed to set out the "facts, events and circumstances", it was invalid. Some of the sellers were even aware of the underlying facts and the investigation (having been actively involved in correspondence, meetings and providing information) but this did not affect the court's decision that the notice itself did not meet the criteria set out in the sale and purchase agreement.
It is important that, before issuing a notice of claim under any indemnity, warranty or tax covenant, you check what you have to do to issue a valid notice. In particular, what information the notice must include, who and where it must be sent and the timing of issuing the notice. Are there specific deadlines or time restraints that need to be followed?
It is also important to ensure the terms of any contract being negotiated work to best protect your position, whether you are buying or selling the company. Tax can be a difficult area for many owner managers who rely on their accountants or others within the organisation to manage the company's tax and accounting affairs. If buyers are aware of any risks and the sellers work with them to best cover these then the chances of disputes and expensive litigating arising later on are reduced.
The decision in this case also reiterates the importance of following the procedures set out in an agreed contract rather than dealing with matters informally or depending on the other party's existing knowledge. If disputes arise, the courts will look objectively at the wording of a contract and apply it to the facts. Understandably, parties may not want to invoke the legal provisions of a contract where they can deal with the issue informally but they should be aware of the risk of not doing so if the issue is not resolved.