Warranty Insurers in M&A Adapt to Brazil’s Tax Contingencies

Warranty and Indemnity (W&I)/Representation and Warranties (R&W) insurance have been gaining traction in Brazilian M&A deals, especially as parties seek protection against complex pre-closing tax contingencies that may materialize post-closing, say Campos Mello Advogados practitioners.

Interest in W&I and R&W insurance coverages have been growing in M&A deals involving Brazilian targets in recent years. W&I/R&W insurers should be prepared to navigate Brazil’s intricate tax landscape, as usually non-materialized tax contingencies have become a key concern in underwriting policies for M&A transactions.

The W&I insurer covers certain losses arising from breaches of the parties’ (usually the seller’s) representations and warranties.

Since it addresses unforeseen issues that may arise after a deal has closed, a thorough and high-quality due diligence process is critical—not only for the parties involved but also for the insurer.

The level and quality of information assessed by the insurance company during the due diligence process to be conducted by its counsel play an important role in the definition of the scope of coverage to be considered in the W&I/R&W policy. The sectors developed by the target company may also impact on the risks to be accepted by the insurer.

A W&I/R&W insurance can be contracted by both the seller and the buyer, with the latter being the more common option.

From a buyer’s perspective, W&I/R&W insurance is attractive as it transfers risk to a solvent and professional third-party (the insurer), particularly if the seller is in distress, consists of individuals, or limits warranty coverage to a short timeframe. Therefore, the buyer’s process of recovering eventual losses arising from seller’s breach of representations and warranties is safer and faster, since the insurer will be responsible for such payment.

From the seller’s perspective, this type of insurance can minimize post-closing exposure and help avoid escrow and/or retentions or deferred mechanisms of purchase price payments (i.e., holdback provisions).

A primary area of concern when considering this insurance relates to tax contingencies. Below, we provide brief insights into the Brazilian tax system and common issues associated with W&I insurance.

Brazil Tax System

Brazil has a complex tax system divided among federal, state, and municipal authorities, each with its own taxing powers. Moreover, Brazilian tax authorities tend to be very assertive in their dealings with taxpayers, offering very limited opportunities for amicable resolutions, which often results in elevated levels of disputes.

Recently, Brazil approved a consumption tax reform aimed at simplifying the system in this area. This reform will undergo a transition period between 2026 and 2032 and will be fully implemented by 2033.

Brazil has also been making changes from an international tax perspective to align with OECD guidelines, particularly in Transfer Pricing (TP) through the introduction of the Arm’s Length Principle (ALP) and under Pillar 2, with the introduction of a Qualified Domestic Minimum Top-Up Tax (QDMTT), called CSLL Surtax in Brazil.

Tax Issues

In light of these developments and in anticipation of forthcoming tax changes, W&I/R&W insurers typically carve out certain tax risks that are difficult and complex to quantify or that may be covered by other types of insurance policies, such as:

• Tax Attributes: The availability or use of net operating losses, tax credits or tax incentives, unless the due diligence report sufficiently supports the claims. Sellers can enhance their position with the assistance of their accounting or consulting firms, particularly by ensuring that all conditions and requirements to secure tax attributes are properly documented. For example, if a tax incentive requires a minimum number of employees and gross revenues, an independent audit report demonstrating compliance with those conditions would significantly facilitate the review process by the underwriter’s advisors. A clear reconciliation that shows how tax losses were calculated, along with key permanent and temporary items influencing the final result, is also valuable.
• Transfer Pricing: Disputes related to TP due to their inherent complexity. Prior to 2024, Brazil had a TP system based on fixed margins and a low level of disputes in this area. With the introduction of the OECD’s ALP, an increase in disputes is expected due to the subjective nature of the new rules, making it a common carve-out, as also seen in the US and European countries.
• Pre-Closing Reorganizations: Tax consequences arising from pre-closing corporate reorganizations, if any. Brazilian federal tax authorities frequently challenge those types of reorganizations which are implemented right before closing, especially if there is evidence that they were implemented solely to avoid taxes or gain tax benefits (such as goodwill deductibility and step-up in assets or indirect transfer of shares). The significance of pre-closing reorganizations and related risks would need to be evaluated on a case-by-case basis.
• State VAT (ICMS) Incentives and ICMS Substitution Regime (ICMS-ST): Tax incentives granted by states to attract investments are difficult to quantify and there are uncertainties in cross-state transactions with respect to ICMS-ST. These are issues that tend to reduce after the consumption tax reform is fully implemented. Materialized Tax Liabilities: Liabilities already under judicial or administrative litigation are usually carved out from W&I/R&W insurance scope but may be covered by other types of insurance products such as Tax Liability Insurance.
• Pillar 2: With the introduction of the OECD’s QDMTT rules in 2025, targets that are part of large multinational groups within the scope of Pillar 2 must ensure they have supporting documentation that complies with the established regulations. Given the complexity of this system, a detailed calculation prepared by a qualified professional may mitigate this risk, potentially allowing for exclusion from the policy.

In addition, it should be considered that certain industries are more prone to tax disputes, particularly before the full implementation of the consumption tax reform. Examples include:

• Telecom: Disputes over whether services are subject to ICMS (State VAT) or ISS (Municipal Service Tax).
• SaaS/Technology: Challenges related to unpaid importation taxes, including debates over whether payments should be treated as royalties or service fees, which carry different tax implications.
• Oil & Gas: Controversies involving withholding taxes on chartered vessels and the use of industry-specific tax and customs regimes.

Therefore, the industry sector developed by the target company of the M&A transaction should also be considered when assessing the tax risks involved, and certain sectors may represent lower tax exposure than others.

Based on our experience assisting W&I/R&W insurers and underwriters, the most important measures to be taken, with the assistance of legal, tax, and accounting advisors, are as follows:

• Conduct thorough due diligence to identify potential risks, focusing on issues that are common within the target’s industry, particularly when reviewing risks involving tax attributes.
• Carefully assess the likelihood of loss related to potential risks based on the current regulations and relevant case law.
• Clearly define the scope of coverage in the W&I/R&W policy to avoid ambiguities.
• Address any carve-outs or specific exclusions in the policy coverage during negotiations to ensure alignment between the parties.
• Combine the W&I/R&W insurance with other types of indemnification provisions or mechanisms to be agreed by the parties in the transaction documents.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Alex Jorge is a partner and co-head of the Tax practice at Campos Mello Advogados. Renata Amorim is a partner at Campos Mello Advogados’ Mergers & Acquisitions, Private Equity, Corporate and Venture Capital practices. Laura Kurth is a senior associate at Campos Mello Advogados’ Tax practice.

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