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Is a Failure to File an FBAR Covered under the Tax Indemnity in a Stock Purchase Agreement?
July 11, 2014
Miscellaneous
My job as a lawyer is to worry about the client’s finances and think of various scenarios that could cost my clients. One worry that has occupied my mind in the past has to do with FBARs and Stock Purchase Agreements. Imagine you are a private equity fund and you purchase a later stage private company. Among the myriad of documents that you will probably sign is a Stock Purchase Agreement, Unit Purchase Agreement (or some other similarly designated purchase and sale agreement if the company is a pass-through entity).   Typically you would hire accountants to do due-diligence. They will prepare a report, you will give it to your tax lawyers and they will go on and draft the tax provisions of the agreement. It is not unusual that the tax people would not talk to the business people. Imagine now that this company has foreign bank accounts. Imagine further that this particular company did not file FBARs for one reason or another.  I know, I know – you’ll say, how is it possible? Well, it is. Now imagine further that your due diligence people did not pick up on this issue.  Again, some would do, some would not. Just bear with me for the sakes of argument. If these several things happen, your hope of catching the issue would be in the SPA.  What you would have is tax representations, tax definitions and tax indemnification. Those are designed to work as follows. You will have a definition of Taxes, Tax Return, Pre-Closing Taxes and so on. In the representations section you will have a few core reps such as Tax Returns filed accurately, Taxes paid on time and so on. If there is a breach in the tax reps or the company did not pay Pre-Closing Taxes, you get indemnified. Now imagine your lawyers looked at the agreement, used the typical precedent in this area, and you signed it. All is fine. You end up hiring new company accountants, who are shrewder than the previous accountants, and they uncover the blunder, i.e. the lack of FBARs. So you say, well, we do the right thing. We file the FBARs. You remedy the problem, but the process may cost you. It could be as low as a few thousand dollars, and as high as 100-150% of the value of the accounts that were not reported (there was a recent case in Florida that upheld this kind of an amount). What do you do? You go after the indemnity.

Will this claim be covered under the typical SPA language? Let’s see. Is the FBAR a Tax Return within the most commonly used definition?  Here is how this definition may read:

"Tax Return" means any return, declaration, report, claim for refund, information return or statement or other document relating to Taxes, including any schedule or attachment thereto, and including any amendment thereof.

Now, this definition is not really that bad. It includes “information returns,” which the FBAR clearly is. The culprit here is “relating to Taxes.” In my mind, there is a pretty decent argument that an FBAR does not relate to Taxes. Let’s look at a typical definition of Taxes.

"Taxes" means all federal, state, local, foreign and other income, gross receipts, sales, use, production, ad valorem, transfer, franchise, registration, profits, license, lease, service, service use, withholding, payroll, employment, unemployment, estimated, excise, severance, environmental, stamp, occupation, premium, property (real or personal), real property gains, windfall profits, customs, duties or other taxes, fees, assessments or charges of any kind whatsoever, together with any interest, additions or penalties with respect thereto and any interest in respect of such additions or penalties.

Most definitions, as in the above definition, will include penalties and interest. However, again, the penalties imposed for failure to file FBARs are not together with Taxes, additions to Taxes, or in respect of Taxes or Income. They are assessed based on unreported account value.  If you are lucky, some other part of the agreement may give you an out, but there is a reasonable argument that the typical boilerplate related to Taxes and Tax Returns would not cover this.  All of this could be quite costly, or may be a non-issue. Nobody knows until a particular scenario plays out.  However, some language along the below lines could have mitigated this predicament and possibly saved us from a few sleepless nights.

"Tax Return" means any return (including any schedule or attachment and any information return), report, statement (including but not limited to Form TD F 90-22.1, if applicable), declaration, estimate, schedule, notice, notification, form, election, certificate or other document or information (including any amendment thereof) filed with or submitted to, or required to be filed with or submitted to, any Tax Authority in connection with the determination, assessment, collection or payment of any Tax or in connection with the administration, implementation or enforcement of or compliance with applicable law relating to any Taxes.
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Tags: FBAR, stock purchase agreement