A tax indemnification agreement is a legal contract in which one party agrees to protect the other from any possible financial penalties incurred as a result of their tax obligations. This type of agreement can be very beneficial for businesses, as it can help them avoid costly fines and penalties from the IRS. In order to enter into a tax indemnification agreement, both parties must agree to its terms and conditions. It is important to work with an experienced attorney when drafting this type of agreement, so that all potential risks are accounted for.
Below is a list of common sections included in Tax Indemnification Agreements. These sections are linked to the below sample agreement for you to explore.
TAX INDEMNIFICATION AGREEMENT dated as of [•], 2010 (this “Agreement”), between THE FRESH MARKET, INC. (the “Company”) and all of the shareholders identified on the signature pages of this Agreement.
WHEREAS the Company has elected to be an S-corporation (the “S Election”) under the Internal Revenue Code of 1986 or the Internal Revenue Code of 1954, as applicable, and in each case as amended (the “Code”);
WHEREAS The Fresh Market of Massachusetts, Inc. (the “Subsidiary”) is a wholly owned subsidiary of the Company and has elected to be a qualified subchapter S subsidiary (the “QSub Election”) under the Code;
WHEREAS the Company intends to conduct an initial public offering (the “IPO”) and, in connection with the IPO, the Company’s S Election and the Subsidiary’s QSub Election will terminate, and each of the Company and the Subsidiary will each be treated as C-corporations under the Code;
WHEREAS at all times the Company’s S Election was in effect, the Shareholders (defined below) paid Federal and certain state and local income taxes on their allocable share of the Company’s Taxable Income (defined below) as determined under the Code and certain equivalent state or local statutes, and the Shareholders will continue to pay such taxes (as they become due) for such periods as the Company’s S Election remains in effect;
WHEREAS the Company is obligated under its shareholder agreement to make pro rata distributions to its Shareholders in amounts equal to the Shareholders’ estimated tax liability, calculated as if each Shareholder would be taxable on its allocable share of the Company’s Taxable Income at the maximum Federal income tax rate and the maximum state and local income tax rates; and
WHEREAS the Company and the Shareholders desire to set forth their agreement that the Company shall bear the risk of any additional tax liability, as well as any related losses, costs and expenses, resulting from (i) any statement or restatement of the Company’s Taxable Income on any income tax return or (ii) any Determination (as defined below), in each case for any open taxable period beginning before the termination of the Company’s S Election;
NOW, THEREFORE, in consideration of the mutual covenants and agreements contained herein, the parties hereby agree as follows:
SECTION 1.01. General . The following terms shall have the following meanings (such meanings to apply equally to the singular and plural forms of the terms
defined). All section references are to this Agreement unless otherwise stated. All references to “includes” and “including” mean “includes without limitation” or “including without limitation”, as the case may be.
SECTION 1.02. Definition of Terms .
“ Company’s Taxable Income ” means the Company’s taxable income, combined with the Subsidiary’s taxable income, as applicable.
“ Determination ” means the final resolution of liability for any tax for any taxable period as a result of (i) a “determination” as defined in Treasury Regulation § 1.1377-2(c), (ii) a final determination made by a competent Taxing Authority or (iii) the payment of tax by the Shareholders if the Shareholders and the Company agree that the payment should be made and no action should be taken to recoup that payment.
“ Proceeding ” means any proceeding that will potentially give rise to a Determination.
“ Shareholder ” means for any taxable period a person who was a shareholder of the Company during all or part of such taxable period.
“ taxes ” means all Federal, state and local taxes, assessments, duties or similar charges of any kind whatsoever, including any interest, additions to tax or penalties applicable thereto.
“ Taxing Authority ” means any governmental body charged with the determination, collection or imposition of taxes.
Payments and Indemnity
SECTION 2.01. Tax Returns. Upon filing any Federal, state or local income tax return (amended or otherwise) for any taxable period during which the Company had an S Election in effect, the Company shall calculate each Shareholder’s estimated tax liability for such taxable period as if each such Shareholder would be taxable on its allocable share of the Company’s Taxable Income at the maximum Federal income tax rate and the maximum state and local income tax rates applicable to each such Shareholder; provided , that in any case where another person or entity is directly taxed on a Shareholder’s income, such Shareholder’s estimated tax liability shall be determined by reference to such other person or entity. The Company shall calculate for each Shareholder the excess of such Shareholder’s estimated tax liability over the amount previously distributed by the Company to such Shareholder in respect of tax liabilities for the relevant taxable period (the “2.01 Excess”). The Company shall make a payment to each Shareholder in proportion to each Shareholder’s shareholdings during the relevant taxable period in an amount sufficient so that the Shareholder with the highest 2.01 Excess receives a payment equal thereto. Payments made pursuant to this Section 2.01 shall be made at the time the relevant income tax return is filed.
SECTION 2.02. Determinations. After any Determination, the Company shall calculate each Shareholder’s estimated tax liability for the relevant taxable period as if each such Shareholder would be taxable on its allocable share of the Company’s Taxable Income at the maximum Federal income tax rate and the maximum state and local income tax rates applicable to each such Shareholder; provided , that in any case where another person or entity is directly taxed on a Shareholder’s income, such Shareholder’s estimated tax liability shall be determined by reference to such other person or entity. The Company shall calculate for each Shareholder the excess of such Shareholder’s estimated tax liability over the amount previously distributed by the Company to such Shareholder in respect of taxes for such taxable period (the “2.02 Excess”). The Company shall make a payment to each Shareholder in proportion to each Shareholder’s shareholdings during the relevant taxable period in an amount sufficient so that the Shareholder with the highest 2.02 Excess receives a payment equal thereto. Payments made pursuant to this Section 2.02 shall be made within 120 days of the relevant Determination.
SECTION 2.03. Indemnification. The Company shall indemnify and hold harmless the Shareholders from any losses, costs or expenses (including reasonable attorneys’ fees) arising out of any claims made pursuant to Section 2.01 or Section 2.02. Payments made pursuant to this Section 2.03 shall be made at the same time as the payment made pursuant to Section 2.01 or Section 2.02, as applicable.
Notice, Proceedings and Inconsistent Reporting
SECTION 3.01. Notice and Proceedings. (a) Any Shareholder that believes it may be entitled to a payment under this Agreement as a result of a Proceeding shall use reasonable efforts to promptly notify the Company of such Proceeding.
(b) The Company will have the option to represent itself in any Proceeding, at its own expense and using advisors of the Company’s choice.
(c) Each Shareholder shall cooperate fully with the Company in any Proceeding and shall have the right, but not the obligation, to participate in such Proceeding at its own expense.
(d) Breach by any Shareholder of any of the provisions of this Section 3.01 will terminate the Company’s obligation to make payments to such Shareholder under Article II, to the extent any such breach materially prejudices the result of any Proceeding.
SECTION 3.02. Inconsistent Reporting. If a Shareholder hereafter reports an item on such Shareholder’s income tax return in a manner materially inconsistent with the tax treatment reflected in the Schedule K-1 or other tax information provided to the Shareholder by the Company for a taxable period during which the Company had an S Election in effect, such Shareholder shall notify the Company of such
treatment before filing such Shareholder’s income tax return. If such Shareholder fails to notify the Company of such inconsistent reporting, such Shareholder shall be liable to the Company for any losses, costs or expenses (including reasonable attorneys’ fees) arising from such inconsistent reporting, including an audit.