Warranties and indemnities when selling a company

When a company is sold, the seller gives warranties (contractual statements about the state of the business) and usually indemnities (promises to repay specific losses) in the sale and purchase agreement. The seller limits that exposure in two main ways: by disclosing known problems against the warranties in a disclosure letter, and by negotiating caps, thresholds and time limits on claims. Warranty and indemnity insurance can shift some of the remaining risk to an insurer, and any payment the seller later makes can reduce the capital gain on the sale.

Tax investigation insurance from £108.75 a year (£9.06 a month).Pays up to £100,000 of your accountant's fees if HMRC opens an enquiry. No excess. Buy online in a few minutes.

See my price in 2 questions How the cover works Accountant? Offer cover to your clients or call 01795 841 310

What is the difference between a warranty and an indemnity?

A warranty is a statement of fact about the company being sold, such as “the accounts give a true and fair view” or “there is no litigation pending”. If it turns out to be untrue, the buyer can claim damages, but it must show both that the warranty was breached and that the breach reduced the value of what it bought.

An indemnity is a promise to reimburse a particular kind of loss whenever it arises, regardless of the effect on value. HMRC’s Capital Gains Manual at CG14825 describes the practical difference: to claim under a warranty the buyer must prove a breach and a quantified loss, while under an indemnity it only has to show that the liability arose and falls within the indemnity. That makes indemnities faster and more certain for the buyer, so sellers usually resist giving them except for specific, identified risks.

Tax is the main exception. ICAEW’s Corporate Finance Faculty guideline on completion mechanisms explains that a buyer will normally seek a generic tax indemnity, often called a tax covenant or tax deed, giving pound for pound redress for historical tax exposures that were not provided for. Higher risk tax issues found in due diligence are dealt with either by a price reduction or by specific indemnities with fewer limits.

What warranties will a buyer usually ask for?

A long list of commercial, legal, employment, property and IT warranties is normal. On the financial side, the same ICAEW guideline describes the usual requests:

that the last statutory accounts show a true and fair view of the financial position and results, with a separate warranty that they were prepared under the applicable accounting framework;
that management accounts reflect the transactions of the business with reasonable accuracy, a lower standard because management accounts are not required to comply with GAAP;
that no material adverse change has happened since the last accounts;
warranties on tax and pension liabilities, and on contingent liabilities such as litigation or environmental claims;
in a locked box deal, a warranty that the locked box accounts are accurate, alongside covenants against “leakage” of value to the seller.

Accountants acting for owner managers should read the accounting warranties closely. A director who signed accounts that were prepared on a simplified basis, or where known adjustments were never made, may be giving a warranty that is already untrue.

Worried about an HMRC check? Tax investigation insurance pays your accountant’s fees if HMRC opens an enquiry or compliance check. Solar Protect cover pays up to £100,000 with no excess. It never pays tax, interest or penalties.

From £108.75 a year (£9.06 a month) for individuals, £117.57 for sole traders and £207.50 for companies and partnerships, including IPT and the £20 admin fee.

See my price in 2 questions or call 01795 841 310.

★★★★★ Rated 4.9 out of 5 on Trustpilot from over 160 reviews

How does the disclosure letter protect the seller?

The disclosure letter is the seller’s answer to the warranties. It lists exceptions: facts that would otherwise breach a warranty, such as a customer dispute, an open HMRC enquiry or an overdue VAT return. ICAEW’s financial due diligence guideline explains that the disclosure letter sets out information relating to the warranties and indemnities so the buyer is aware of it before signing, which limits the buyer’s ability to claim damages later. The completion mechanisms guideline adds that warranties are normally given subject to fair disclosure of factors the buyer has been made aware of in due diligence.

Disclosures usually come in two layers:

General disclosures of whole categories of information, such as everything in the data room, public registers at Companies House, and the statutory books. Buyers often negotiate these down.
Specific disclosures against numbered warranties, with enough detail for the buyer to understand the nature and scale of the issue. A vague reference to “ongoing discussions with a customer” may not count as fair disclosure.

ICAEW notes that the virtual data room keeps a record of documents shared, which is important evidence for the disclosure letter.

How can a seller cap or limit liability?

Limitations are a matter of negotiation, not law, but a typical seller friendly schedule includes:

An overall cap, often linked to the price, with a lower cap for general warranties than for title and tax.
A de minimis amount below which individual claims are ignored, and a threshold or basket that aggregate claims must exceed before any can be brought.
Time limits for notifying claims, usually shorter for commercial warranties than for tax.
Exclusions for anything disclosed, items provided for in the accounts, changes in law after completion, and losses the buyer could have recovered from insurance or by mitigation.
Conduct of claims provisions letting the seller defend third party claims, such as an HMRC enquiry into a period before completion.

If the agreement says nothing about time, the Limitation Act 1980 applies in England and Wales: six years for a simple contract under section 5, and twelve years for a deed under section 8. Buyers may also ask for part of the price to be retained or paid into escrow. ICAEW’s guidance describes both being used to secure money the seller may have to repay after completion.

What is warranty and indemnity insurance?

Warranty and indemnity (W&I) insurance covers losses from breaches of the warranties and, depending on the policy, the tax indemnity. ICAEW’s carve out guideline notes that a seller may reduce its exposure after completion through a W&I policy, either obtained for itself or, more commonly, obtained by the buyer. With a buyer side policy the buyer looks to the insurer rather than the seller for covered losses, which can help the seller negotiate a lower cap.

Underwriters rely heavily on the due diligence. ICAEW’s due diligence guideline notes that reports may be made available to W&I insurers, and the carve out guideline says the quality of diligence informs the cover offered. As a form of general insurance, a UK policy will normally carry Insurance Premium Tax, which is 12% at the standard rate.

How is a warranty payment taxed for the seller?

Under section 49(1)(c) of the Taxation of Chargeable Gains Act 1992, no allowance is made at the time of sale for a contingent liability under a warranty or representation. The gain is computed on the full price. If the liability later becomes enforceable and is enforced, section 49(2) allows a claim to adjust the gain. HMRC’s guidance at CG14805 says the gain is recomputed as if the consideration had been reduced by the payment, and that the four year claim period under section 43 of the Taxes Management Act 1970 runs from the date all the conditions for the claim are met, which may be when a disputed claim is finally settled.

Other points from HMRC’s manual:

the consideration cannot be reduced below nil, so a payment larger than the price only produces a loss up to the base cost (CG14807);
legal costs of fighting a warranty claim are not allowable (CG14809);
an indemnity is strictly outside section 49, but under paragraph 13 of extra statutory concession D33 HMRC in practice allows section 49 treatment for indemnity payments by the vendor (CG14825).

If the adjusted computation produces a loss, see capital losses. For how the original gain and any relief are worked out, see how capital gains tax is calculated and business asset disposal relief.

How is the payment treated by the buyer or the company?

CG13010 says a payment to the buyer under a warranty or indemnity is a capital sum derived from the shares, and in practice reduces the buyer’s base cost. If the agreement directs payment to the target company instead, the treatment follows its character: a reimbursement of allowable trading expenditure is a trading receipt, and other payments are capital sums derived from the company’s contractual rights.

How might this work?

Illustration only. Sam sells all the shares in a trading company for £1,000,000. The shares cost £100. The agreement caps general warranty claims at 30% of the price, with a two year claim period. Sam discloses a customer dispute but not a VAT error that he did not know about. Eighteen months later HMRC assesses £40,000 of VAT for a period before the sale, and Sam pays the buyer £40,000 under the tax covenant. Although that is an indemnity payment, HMRC’s practice under concession D33 means Sam can claim to have the gain recomputed on £960,000 of proceeds and recover the tax overpaid. If the buyer had held a W&I policy covering the tax covenant, the buyer might instead have claimed against the insurer, depending on the policy terms.

What mistakes do sellers make?

Treating the disclosure letter as a formality and making vague or late disclosures.
Agreeing broad indemnities for general risks, rather than limiting them to specific issues identified in due diligence.
Forgetting that management accounts and recent trading figures supplied in negotiations may be warranted.
Not keeping part of the proceeds available while claims periods are running.
Missing the four year window for a section 49 claim once a warranty payment is settled.

Company sales often involve share for share exchanges or deferred consideration, each with its own warranty and tax points.

Company directors can protect the business against the cost of an HMRC check with tax investigation insurance, which pays up to £100,000 of accountant’s fees with Solar Protect. Read how our cover works or get a quote.

Related Accountapedia entries

Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.