Rig Holdings LP v Aeroflex Test Solutions Ltd

A contractual tax-loss indemnity must be construed according to the accounting assumptions and mechanism expressed in the agreement. Where the agreement was drafted on the basis of a 12-month accounting period ending on 31 December, a later change to an 18-month accounting period may be disregarded when calculating the parties’ contractual entitlement. A party’s failure to procure a required computation does not prevent the other party from proving what the computation should have shown, applying the principle in Mackay v Dick (1861) 6 App Cas 251. That principle cannot, however, create a contractual entitlement which the proper construction of the tax deed does not support.

The claimant, as assignee of the seller’s rights, sought payment under a tax deed entered into alongside a share purchase agreement. The claim concerned losses incurred in the seven months before completion and an alleged taxable profit in the remaining five months of 2003.

After completion, the company changed its accounting date from 31 December to 30 June and prepared accounts for an 18-month period. The claimant relied on an apportionment of that period to calculate a profit for the final five months of 2003. It also argued that the contractual computation procedure had made the calculation binding, or alternatively that the buyer’s failure to procure a required computation entitled it to recover. The central issue was the proper construction and application of the tax deed’s calculation mechanism.

1. The claim was dismissed. The contractual mechanism had to be construed in the context of the tax deed as a whole and its underlying assumptions.
2. The deed was drafted on the basis that the company’s accounting period was, and would remain, the 12 months ending on 31 December. Clauses 8.5 and 13.5(D)(i) reinforced that conclusion by requiring the adoption of past tax-reporting practices.
3. The later change to an 18-month accounting period ending on 30 June 2004 was not itself a breach of the deed. For the purposes of clause 13, however, it had to be ignored. The profit made in the six months to 30 June 2004 was therefore irrelevant, because the contractual cut-off date was 31 December 2003.
4. The claimant could not rely on contractual finality in relation to the alleged five-month profit because no computation for that period had been prepared and provided in accordance with the agreement. The buyer’s failure to procure that computation was a breach. Applying the principle in Mackay v Dick (1861) 6 App Cas 251, the claimant could in principle prove what the computation should have shown and claim the resulting sum or damages.
5. That conclusion did not assist the claimant. On the proper contractual basis, the five-month period did not produce the claimed profit. The alternative calculations advanced by the claimant were also unsupported by the wording of the deed, including clause 13.5(A) and the assumptions required by clause 13.5(D)(ii).