Clause primer
Withholding tax gross-up clause
If the payer must withhold tax from a payment, it pays an additional amount so the recipient receives what it would have received with no withholding, subject to listed exclusions.
Legal information, not legal advice. What a clause does depends on its exact words, the rest of the agreement and the governing law.
Also called: tax gross-up, taxes clause, increased payment for taxes. Where you find it: Credit agreements, note purchase agreements, indentures, receivables purchase agreements, supply chain finance programs and cross-border intercompany loans.
SAMPLE CLAUSE (INVENTED FOR THIS PRIMER)
All payments by the Obligor under this Agreement shall be made without deduction or withholding for any Taxes, unless required by law. If any Indemnified Taxes are required to be withheld, the Obligor shall pay such additional amounts as are needed so that the recipient receives the amount it would have received had no withholding been made. "Indemnified Taxes" excludes (a) Taxes imposed because of a present or former connection between the recipient and the taxing jurisdiction, other than one arising solely from this Agreement, (b) Taxes attributable to the recipient's failure to deliver the forms required by Section 3.4, and (c) withholding Taxes in effect when the recipient became a party.
How it works
Payment without withholding
The starting point is that payments are made in full, unless law requires withholding.
Additional amounts
The gross-up is calculated so that the net amount equals the amount due before withholding. Because the additional amount may itself be taxed, the cost exceeds the headline rate.
Connection exclusion
Taxes that arise from the recipient's own presence or activities in the taxing jurisdiction are the recipient's problem. The exception for a connection arising "solely from this Agreement" keeps the payer responsible where the deal itself creates the link.
Forms and timing exclusions
The payer does not gross up tax that the recipient could have avoided by delivering tax forms, or tax that already applied when the recipient joined. Check whether assignees inherit the original party's protection or start fresh.
Why it is there
Lenders and investors price a deal on a net yield, and withholding tax would reduce that yield. The gross-up moves the risk of withholding to the payer for taxes it controls or that result from the transaction, while leaving with the recipient the taxes caused by its own status, location or inaction.
How it works with other clauses
- A tax forms or cooperation covenant usually requires the recipient to deliver forms that reduce or remove withholding, and failure to deliver is an exclusion.
- A mitigation clause may require the recipient to change lending office to reduce the cost, and a replacement clause may let the payer remove a recipient claiming gross-up.
- Assignment and participation provisions determine whether a new holder can claim more gross-up than the original holder.
Negotiating it
Who it protects: Lenders, noteholders and purchasers
If it protects you
- Keep the change-in-law protection, so new withholding imposed after you join is grossed up.
- Make sure the "connection" exclusion carves out connections created solely by entering into and enforcing the deal.
- Include a direct tax indemnity alongside the gross-up.
If it runs against you
- Standard ask: full exclusions for connection taxes, form failures and taxes in effect at joining; fallback is to keep at least the form failure exclusion.
- Ask that assignees receive no greater gross-up than their assignor unless the payer consented to the transfer.
- Ask for a mitigation duty and a right to replace a recipient that claims gross-up.
Escalate before accepting: A gross-up with no exclusion for the recipient's own connection or failure to deliver forms, because the payer then bears taxes it cannot control or avoid.
What AI explanations get wrong
- Describing the gross-up as covering all taxes. Check the definitions of "Taxes", "Indemnified Taxes" and "Excluded Taxes", which usually do most of the work.
- Calculating the cost at the face withholding rate. Check whether the additional amount is itself subject to withholding, which raises the effective cost.
- Stating a specific withholding rate or treaty result as if it applied to the reader's deal. Check with tax counsel; rates depend on the parties, the payment and any treaty.
- Ignoring assignment. Check whether a transferee can claim more than its transferor.
Where the law varies
Whether withholding applies, at what rate, and whether a treaty or exemption reduces it depends on the tax law of the payer's jurisdiction, the type of payment and the recipient's status. Tax counsel should confirm the position for each jurisdiction involved.
Sources
- 26 U.S. Code § 1441 - Withholding of tax on nonresident aliens
- 26 U.S. Code § 1442 - Withholding of tax on foreign corporations
TOOLS
Need a primer like this for a clause in front of you? The Clause Primer Kit, included in All-access, produces one in this format inside the AI tool you already use, with checks built in. For reviewing whole agreements, see the Agent Kit 1: Contract Review and Negotiation.