Tax indemnifications: Overview, definition, and example
What are tax indemnifications?
Tax indemnifications are contractual provisions that require one party to compensate another for tax liabilities that arise due to specific circumstances. These clauses are commonly used in mergers, acquisitions, and other financial agreements to protect a party from unexpected tax burdens.
For example, if a company being acquired has unpaid taxes from previous years, a tax indemnification clause can ensure that the seller, not the buyer, remains responsible for those liabilities.
Why are tax indemnifications important?
Tax liabilities can be significant and unexpected, making tax indemnifications a crucial protection in business transactions. Without such a clause, a company might inherit tax debts from a previous owner or partner, leading to financial losses.
For example, if a small business acquires another company and later discovers the seller failed to pay certain taxes, the buyer could be held responsible. A tax indemnification clause ensures that the seller covers those costs instead of shifting the burden to the buyer.
Understanding tax indemnifications through an example
Imagine you are purchasing a software company. After the deal closes, you receive a notice from the tax authorities stating that the company owes $100,000 in back taxes from before the sale.
If your purchase agreement includes a tax indemnification clause, the seller is required to cover those unpaid taxes. Without this clause, you might have to absorb the unexpected cost, reducing the value of your acquisition.
An example of a tax indemnification clause
Here’s an example of how a tax indemnification clause might appear in a contract:
“The Seller agrees to indemnify and hold harmless the Buyer from and against any and all tax liabilities, including penalties and interest, attributable to the period prior to the Closing Date. The Seller shall promptly reimburse the Buyer for any amounts paid in connection with such tax liabilities.”
This clause ensures that the seller is responsible for any taxes due before the sale, protecting the buyer from unexpected financial burdens.
Conclusion
Tax indemnifications are a key tool for protecting businesses from unexpected tax liabilities in mergers, acquisitions, and financial agreements. For SMBs, including a tax indemnification clause in contracts helps prevent surprises and ensures that the correct party is responsible for past tax obligations.If you’re buying or selling a business, reviewing tax liabilities and negotiating a tax indemnification clause can save you from costly disputes and financial losses in the future.
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.