What should a tax indemnity in a share purchase agreement cover?

In a share purchase the buyer takes the company, and the company that the Canada Revenue Agency (CRA) can reassess is still the company the buyer now owns. A tax indemnity moves the cost of earlier tax problems back to the seller. It is separate from the representations and warranties; reps and warranties versus indemnities explains the difference, and the glossary entry on an indemnity gives the basics.

Which taxes and which periods

Name each tax the company pays: income tax, GST/HST (imposed under Part IX of the Excise Tax Act) and payroll source deductions. The Income Tax Act assesses a taxpayer by taxation year, so the clause should say how a year that straddles the closing date is split between the seller’s period and the buyer’s. The page on unpaid source deductions and HST in a share purchase explains why those items matter.

How long it should last

The Income Tax Act sets a normal reassessment period for each taxation year, and the length depends on the kind of taxpayer (s. 152(3.1)). After that period, an assessment can be made only in the cases listed in s. 152(4), which include a misrepresentation attributable to neglect, carelessness or wilful default, fraud, or a waiver in prescribed form filed within the normal reassessment period, subject to the limits in s. 152(4.01). The survival period of the indemnity is a negotiated term, so compare it with the reassessment period for each year the clause covers and ask a tax adviser how the gap should be handled.

Items to raise with your advisers

• Interest and penalties on top of the tax, and the buyer’s cost of contesting an assessment.
• Who is told of a CRA audit, who controls it, and whether the seller may settle without the buyer’s consent.
• Any refunds or credits of the company from before closing.
• If the seller may be a non-resident, section 116 of the Income Tax Act can make a purchaser of taxable Canadian property liable to remit tax, unless an exception applies, such as a certificate issued by the Minister or the purchaser having no reason, after reasonable inquiry, to believe the seller was non-resident.
• Whether the seller can pay: a holdback or escrow gives the promise something behind it.

After closing, CRA’s page on changing owners says that structure or owner changes for a corporation must be updated and validated with the federal or provincial incorporating authorities before the CRA is contacted.