General tax covenant: Overview, definition, and example
What is a general tax covenant?
A general tax covenant is a provision in a contract, typically in corporate transactions or financing agreements, where one party agrees to assume responsibility for tax liabilities and ensure compliance with tax laws. This covenant is often included to protect parties from unexpected tax burdens that may arise due to actions taken during the course of the agreement, such as mergers, acquisitions, or loans. The general tax covenant can outline the obligations of the parties regarding tax filings, tax payments, and the resolution of any tax disputes that arise during the term of the agreement.
Why is a general tax covenant important?
A general tax covenant is important because it provides clarity on the allocation of tax risks between the parties involved in a transaction. It ensures that the party assuming responsibility for tax liabilities will cover any taxes due, avoiding financial penalties or disputes that could arise after the agreement is executed. For buyers and investors, a general tax covenant can offer protection against unforeseen tax liabilities that might be triggered by actions taken by the other party before the transaction is completed. This covenant is crucial for managing tax risks and ensuring compliance with applicable tax laws, helping both parties avoid costly mistakes.
Understanding general tax covenant through an example
For example, a company acquires another company through a stock purchase agreement. As part of the deal, the seller agrees to a general tax covenant, where they promise to be responsible for any unpaid taxes or tax disputes that may arise from the period before the acquisition. If the seller has not paid certain taxes due from prior years, the general tax covenant ensures they will cover those liabilities even after the transaction closes, protecting the buyer from being held accountable for taxes incurred prior to the acquisition.
In another example, a loan agreement might include a general tax covenant where the borrower agrees to comply with all tax laws and to pay any taxes associated with the loan, including withholding taxes on interest payments. If the borrower fails to meet these obligations, the borrower would be responsible for any penalties, interest, or other tax liabilities, as outlined in the covenant.
An example of a general tax covenant clause
Here’s how a general tax covenant clause might appear in a contract:
“The Seller hereby covenants that it shall remain responsible for all taxes owed, accrued, or assessed prior to the Closing Date, including any liabilities arising from prior transactions. The Seller agrees to indemnify and hold the Buyer harmless from any claims, penalties, or interest related to such taxes. The Buyer shall not be responsible for any tax obligations incurred by the Seller prior to the Closing Date.”
Conclusion
A general tax covenant is an essential provision in many contracts and agreements, particularly in mergers, acquisitions, or financial transactions. It helps allocate tax risks and responsibilities between the parties, ensuring that one party is not unfairly burdened by taxes due to the other party's actions. By including a general tax covenant, parties can manage potential tax liabilities more effectively and ensure compliance with applicable tax laws, reducing the likelihood of future disputes or financial surprises.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.