TAX INDEMNITIES may be barred by the statute of limitations

TAX INDEMNITIES may be barred by the statute of limitations

February 01, 2001
TAX INDEMNITIES may be barred by the statute of limitations.

Companies with possible indemnity claims should make a formal claim for payment, even if they are contesting with the government — at the request of the idemnitor — whether the taxes are owed.

Tax indemnities are common in lease financing transactions and in mergers and acquisitions. In a lease financing, the lessee usually promises the lessor — or institutional equity — that it will receive certain tax benefits from the transaction. In corporate acquisitions, it is customary for a parent company selling a subsidiary to indemnify the buyer against any taxes that relate to events or periods before the sale.

Norfolk Southern was the lessor in a “safe harbor” lease of 38,000 shipping containers in the early 1980’s. The lessee was Flexi-Van. The IRS took the position that Norfolk Southern was not entitled to investment tax credits or accelerated depreciation on the containers because Northern Southern could not prove they were used to carry cargo “to and from” the United States. The IRS let taxpayers who could not prove this settle on the basis that half the containers qualified. Norfolk Southern rejected the settlement at the request of Flexi-Van and — also at Flexi-Van’s request — pursued the case all the way to the US Supreme Court.

It lost. Flexi-Van then refused to pay a tax indemnity on grounds — among other reasons — that the indemnity claim was barred by the statute of limitations. A formal claim for payment must be made within six years after the claim arises under a tax indemnity governed by New York law. A federal district court in New York said Norfolk Southern made a timely claim, but just barely before the six years had run. The court said the six years begins to run from when the tax is paid to the US government. The court released its decision in December.

The lesson is to make a formal claim early in the process. A notice to a lessee that the IRS disallowed the tax benefits is not a claim for payment of an indemnity.

Keith Martin