A warranty and indemnity policy covers the unknown. A tax position both parties know to be arguable, or know is already under challenge by the authority, is known by definition: it falls out of the policy under the first family of exclusions. Yet it is often the largest figure in the file, the one that decides whether the deal happens. That contradiction is not a flaw in the product, it is its boundary, and another product begins there: the specific tax liability policy. It must be understood as a contract of another nature rather than as an extension of the warranty cover, failing which one applies to it reasoning that does not hold.
The inversion is as follows, and it is the heart of this module. A warranty policy insures uncertainty about FACTS: nobody knows whether a dispute is brewing, whether a contract carries a change of control clause, whether the accounts are true. A tax liability policy insures uncertainty about the LEGAL CONCLUSION drawn from facts everyone knows and nobody disputes. The buyer, the seller and the authority know exactly what was done; they disagree about what it means in law. The insured object is therefore not an event, it is the outcome of an argument.
That changes underwriting entirely. The underwriter is not looking for facts, it is assessing an argument. It requires a reasoned opinion from counsel, given at a stated level of conviction, and it prices the gap between that level and certainty. Below a certain threshold of conviction there is no market at all: nobody insures a position the taxpayer's own counsel will not defend. From this follows a consequence practitioners underrate, and it shifts responsibility: it is the tax lawyer drafting the opinion who determines, in practice, whether the risk is insurable. The quality of that reasoning is no longer only an argument before the authority, it has become a condition of access to a market.
The value of this product in a deal is best seen by looking at what happens without it, and that is where the module becomes useful. Facing an identified tax exposure of, say, thirty million, the parties have three tools and all of them are bad. A specific indemnity from the seller keeps it on risk and prevents a fund from distributing. A price reduction, which the seller refuses since it is convinced it will win. An escrow, which locks up cash for years on somebody's balance sheet. Each of these tools requires one party to accept the other's estimate of probability, and that is precisely what they will not do, each being sincerely convinced it is right.
The policy resolves that deadlock in an elegant way worth naming: it converts a disagreement about probability into a premium. The seller need not concede it might lose, the buyer need not accept that it will win, and the risk leaves both balance sheets. The seller distributes, the buyer is protected, and the deal completes on a line that would otherwise have killed it. This is one of the rare places in the subject where insurance does more than transfer an already allocated risk: it makes possible a transaction that would not have happened, which explains why its cost is rarely argued about once the deadlock is apparent.
The trap in the product lies in the definition of the insured position, and it must be addressed before drafting. The policy covers the position as described. If the authority attacks on another ground, or if the facts turn out to differ from those the opinion described, the cover may fail even though the amount assessed is the one anticipated. The temptation at placement is to define narrowly: that is what the opinion analyzed, it is easier to underwrite, it is cheaper, and an adviser may legitimately present a tight definition as a negotiating win. The right instinct is the opposite. The definition must cover the transaction and the grounds an authority could realistically run against it, because an inspector is not bound by the argument the taxpayer's adviser anticipated.
Two mechanics remain to keep in mind when putting the cover in place. Conduct of the dispute no longer belongs entirely to the insured: the insurer is paying for a line of reasoning it underwrote, so it approves the defense and sometimes directs it, and an insured who settles alone for commercial reasons can lose its cover. And the interaction with the warranty policy is settled explicitly or it is settled badly: the specific policy takes the identified item, the tax warranty in the W&I policy covers the rest, and one must check that no wording lets the two insurers point at each other. One practical difference is worth noting to close: because the risk is identified, a tax liability policy can be placed after signing, which a warranty policy can never do once the buyer knows.
An acquirer buys a group at an enterprise value of 420 million euros. A tax point is identified during the review: an intra-group financing restructuring carried out in 2021, on which the authority has opened an inquiry without yet issuing an assessment. The exposure is computed at 34 million including interest. Tax counsel's opinion concludes that the position should be upheld, at a high level of conviction. The seller, a fund at the end of its life, refuses a specific indemnity that would prevent it from distributing and refuses the corresponding price reduction; the buyer refuses to carry 34 million. The deal is about to fail. A tax liability policy is placed for 34 million, the insured position being defined as the deductibility of intra-group interest arising from the 2021 restructuring. Twenty months later, the authority assesses 31 million, but on a different ground: it argues that one of the entities used constituted a permanent establishment in France. Does the policy respond?
The answer depends entirely on the definition adopted, and that is the whole lesson of the case. As drafted, the insured position concerns the deductibility of intra-group interest. An assessment founded on the existence of a permanent establishment is not that argument: it attacks the same restructuring by another route, with different provisions and different relevant facts. The insurer will argue this is not the risk it underwrote, and it will have a text on its side. The mistake was not made at the assessment but at placement, and it wore the appearance of a success: defining narrowly reassures the underwriter, costs less, corresponds exactly to what the opinion analyzed, and an adviser may sincerely present it as a well conducted negotiation. The opposite was required. An authority is not bound by the argument the taxpayer's adviser anticipated, and it picks the ground that looks strongest to it when it assesses, often years later. The definition should therefore have targeted the tax treatment of the 2021 restructuring as a whole, even if that meant the underwriter requiring a supplementary opinion on permanent establishment and adjusting its pricing. That would have cost somewhat more and would have covered the loss that actually occurred. In a tax liability policy, the definition of the insured position is worth more than the limit: a limit set too low leaves part of the damage uncovered, a definition drawn too narrowly leaves none of it covered.
- 01The warranty policy covers the unknown; an identified tax position is known by definition and falls out: it is another product, not an extension.
- 02What is insured is uncertainty about the legal conclusion drawn from facts everyone knows, not uncertainty about the facts.
- 03The policy converts a disagreement about probability into a premium, which unblocks a deal where each side is sincerely convinced it is right.
- 04The definition of the insured position is worth more than the limit: the authority is not bound by the ground the adviser anticipated.
- 05The insurer pays for reasoning it underwrote: it approves the defense, and settling alone for commercial reasons can forfeit the cover.