Tax Insurance: A Cure for the Common SPAC

Special purpose acquisition companies (each, a SPAC) have become a household name. In fact, it seems like a conversation nowadays about the stock market or M&A activity is incomplete without the mention of a SPAC – and for good reason; through the early morning of March 24, there have already been 291 SPAC IPOs with gross proceeds of approximately $94.4b in 2021 (vs. 248 and $83.3b, respectively, in all of 2020),[1] and this is before the UK and the Netherlands pave the way for SPACs in their respective stock markets. Countless articles have already been written about the appeal, benefits and perils of a SPAC over a traditional IPO. But outside of tax publications, the tax risks inherent in SPAC structures and de-SPAC transactions have received very little attention, perhaps by design to avoid redundancy.

A typical Form S-1 for a SPAC already contains a lengthy “tax considerations” section that discusses the many U.S. federal income tax uncertainties including (i) the allocation of purchase price between the common shares and the fraction of a warrant that together comprise the investment unit, (ii) the characterization of the investment unit, (iii) taxation on the disposition of the investment unit, and (iv) the treatment of the SPAC as a personal holding company (PHC) or a passive foreign investment company (PFIC) for US- and foreign-domiciled SPACs, respectively. Such discussion always includes a bold, all-caps statement urging potential investors to consult with their own tax advisors regarding these issues.

There are additional tax risks to navigate, particularly with respect to the de-SPAC transactions (i.e., the transaction by which the SPAC and the operating company combine). These risks include (i) inversions under Section 7874 in situations where a US-domiciled SPAC combines with a non-US operating company, and (ii) qualification of the combination as a tax-free reorganization, and specifically, meeting the continuity of business enterprise requirement of Treas. Reg. 1.368-1(d) in situations where, for legal and/or commercial reasons, the SPAC itself is the target rather than the acquirer in the combination transaction. Although it is possible to solve for some of these issues structurally, no single structure functions as a silver bullet that can solve the gambit of applicable tax risks. This is where tax insurance comes in. Much like a SPAC’s historical existence and recent rise to prominence, tax insurance has been around for decades and is at the cusp of an eruption in popularity and use.

Like a SPAC’s take on an IPO, tax insurance challenges the status quo for the residual risk and uncertainty inherent in tax advice, innovating an established problem into a creative, dynamic and powerful solution.

Tax insurance provides financial protection against losses arising from the failure of a tax position to qualify for its intended tax treatment. A bound policy eliminates the residual risk inherent in taking the tax position based solely on tax advice. Specifically, tax insurance affords taxpayers financial certainty by covering the potential tax liability, related interest and penalties, costs incurred to defend the position and contest any assessment, as well as a gross up for any tax liability incurred upon the receipt of insurance proceeds. In this regard, although not providing the same comfort level afforded by a private letter ruling (PLR), by making a taxpayer financially whole, tax insurance provides the same financial protection as a PLR. As such, tax insurance facilitates both M&A activity and tax planning initiatives by shifting risk to the insurance market. Protected by a bound tax insurance policy, a taxpayer will be made whole by an A-rated insurer (or insurers) in case the tax position is successfully challenged by a tax authority in the future. Furthermore, tax insurance is perfectly permissible. In fact, the IRS affirmed in published guidance (most recently in February 2020) that taxpayers may obtain tax insurance to protect against potential tax liabilities.

Tax insurance has matured from its early days as a rare and costly proposition, and into a cost-effective, common, and practical solution. This is due to increasingly sophisticated tax professionals entering the industry on both the brokerage and underwriting fronts. Accordingly, tax insurance is becoming an integral part of a comprehensive solution to tax issues and business objectives. SPAC founders, financial sponsors and potential investors should consider tax insurance as a mitigant to the common tax risks presented by SPACs, as a bound policy provides financial certainty regarding the insured tax position.

To find out more about the benefits and applications or tax insurance, including policy terms, pricing, underwriting requirements and general process, stay tuned for my article to be published in Tax Notes on April 5th. In the meantime, feel free to contact me or my team at McGill and Partners. We are uniquely positioned to craft a bespoke policy tailored to suit the facts and circumstances of the tax risk for which insurance protection is sought – whether or not SPAC-related.

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About McGill and Partners

McGill and Partners is a boutique insurance broker focused on exceptional client service and superior results. Our decades of global experience combined with legal, "Big4" accounting and investment banking backgrounds enable us to deliver market-defining risk solutions. We have structured M&A insurance across the M&A spectrum including buy-outs, corporate acquisitions, minority investments, carve-outs, take-privates, fund restructurings, de-SPAC transactions and GP-led secondaries transactions. With our experience, creativity and tenacity, we help clients embrace acquisition opportunities with confidence.

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If you would like more information, please contact:

Yoav Shans | [email protected]

James Swan | [email protected]

Jeff Buzen | [email protected]

Charles Inglis | [email protected]

Sam Murray | [email protected]

Edward Ring | [email protected]

End Notes

[1] SPACInsider, “SPAC IPO Transactions: Summary by Year.”

McGill Global Risk Solutions LLC is the US licensed entity of McGill and Partners. This document is for the benefit of clients and prospective clients of McGill and Partners and McGill Global Risk Solutions LLC only. It is intended to highlight general issues and benefits relating to its subject matter and does not take into account the individual circumstances or requirements of individual recipients. It does not constitute legal advice and should not be relied upon as such. Specific advice about your particular circumstances should always be sought separately before taking any action based on this publication.