A tax lawyer with Norton Rose Fulbright, Segal’s practice includes public and private M&A, debt restructurings, corporate finance, corporate reorganizations, structuring private equity investments, advising domestic and cross-border investment funds and international tax planning for Canadian and foreign corporations. He also acts as counsel on federal and provincial tax audits and appeals. Segal is highly experienced with transactional insurance such as representations and warranties (R&W)  insurance and tax liability insurance, and is a sought-after expert on the underwriting of tax insurance.

Segal sat down with BFL CANADA Vice-President – Mergers and Acquisitions Sean Flinn to discuss this emerging and innovative insurance solution.

BFL: Could you please provide a general introduction to tax insurance and its availability in the Canadian market?

Segal: Tax insurance is protection against an adverse finding (typically, a reassessment of tax) by a tax authority which is contrary to the intended or expected tax treatment for a particular transaction.  It is relatively new to the Canadian market and seems to have been around for 3 or 4 years.

BFL: In what sorts of scenarios can tax insurance be used? I originally thought it was solely for identified tax issues in an M&A deal.

Segal: Stand-alone tax insurance can be appropriate for any material tax issues in an M&A deal, which would then be excluded from the more general R&W policy.  For the most part, the tax policies that have been sought or written in Canada in the M&A context have been for transactions outside the deal itself — such as to insure aspects of a pre-closing set of transactions or a post-closing reorganization.  However, there have also been policies written to cover tax risks outside of the M&A context, such as for general tax planning, audits, and even pending court challenges.

BFL: Can you provide some examples of the sorts of tax risks that have been covered? I’m imagining myself in the shoes of a tax lawyer or advisor whose client has a potential issue.

Segal: We have seen submissions for policies that deal with mind & management and permanent establishment (PE) risk, planning to use loss carryforwards in complex pre-closing reorganizations, treatment of proceeds as capital gains vs income, application of debt forgiveness rules, characterization of property as “taxable Canadian property,” certain aspects of a public company divisive (i.e., “butterfly”) reorganization, the application of tax treaty exemptions, the imposition of land transfer tax, GST/HST issues, and of course, the general anti-avoidance rule (GAAR) – among others.

BFL: So tax insurance is used outside of the M&A context.

Segal: Absolutely.  In fact, the largest policy (by dollar amount) that we have been involved with insured against exposure on a complex multi-jurisdictional restructuring which had no connection to M&A at all. One of the first policies that we worked on related to the insured claiming GST/HST tax rebates on sales.  I also think that high-net-worth estate planning would be fertile ground for tax insurance.

BFL: What are some benefits of utilizing this type of insurance?

Segal: A taxpayer may be unwilling to assume the risk of a tax position in a transaction (whether in or out of the M&A context) which is not completely certain, or they may be facing a pending audit or assessment. Purchasing tax insurance allows them to push some of that risk to an insurance carrier.  Aside from dealing with the tax risk, that approach may also positively impact financial reporting and help corporate directors, trustees and other fiduciaries to discharge their duties.

BFL: How can tax insurance change the playing field when an identified tax issue arises? 

Segal: Most policies focus on either a single issue or a small number of issues. We generally haven’t seen policies (outside the M&A rep & warranty experience) that cover, for instance, blanket tax coverage of a seller for a pre-closing tax period.  Instead, they seem to be focused on the application of a particular provision of the tax rules, the characterization of a transaction one way or the other, and the application of GAAR or other anti-avoidance provisions. It is, of course, more challenging if the issue is already on the radar of the CRA or another tax authority, but we have seen policies that underwrite tax risks which are under audit, and in once case even where the taxpayer had already been reassessed (incorrectly, as it turned out).

BFL: In your experience, who is utilizing tax insurance? Buyers, sellers, or a combination of both? Strategic buyers or private equity?

Segal: All of the above, plus, as I noted earlier, taxpayers outside of the M&A context have also purchased insurance for tax risks.

BFL: I understand that a legal memo was initially required for tax insurance but is no longer a prerequisite for underwriting?

Segal: I think it depends on the insurer and the risk. All of the policies that I have seen move forward had fairly complex issues and significant dollar amounts.  The insurers will rely on our advice in deciding whether to underwrite the risk; they are often looking for a relatively high degree of comfort and a detailed legal analysis to support their decision.  We also assist them by advising what additional documentation they should seek, and we sometimes conduct diligence calls with the taxpayer and their advisers.

BFL: Regarding more challenging risks, can you speak to the ability to cover a tax risk that is under review or audit?

Segal: As I mentioned, we have seen a few policies put in place where the taxpayer was under audit.  This will have an impact on pricing. Also, in Canada, a “large corporation” (as defined) is generally required to pay 50% of taxes that are reassessed.  Therefore, this also raises the issue of whether the insurer will agree to cover this up-front amount as part of the insured’s contest costs.

BFL: What has been the user feedback on tax insurance?

Segal: Very positive to say the least. Based on my experience to date I expect significant growth in the number of policies that will be issued in the next few years, as business, legal and tax advisors (plus boards, trustees and other fiduciaries) become more familiar with the product. The pandemic has probably slowed growth somewhat in 2020, but there is no reason to believe it will not pick right back when we are through this difficult period.

Do you have questions about tax insurance? Could you use some professional advice?