Tax due diligence (TDD) is one of the least studied – but yet the most crucial – aspects of M&A. The IRS isn’t able to audit every single company in the United States. Therefore, mistakes and oversights made in the M&A procedures can result in massive penalties. A well-planned preparation and detailed documentation can assist you in avoiding these penalties.
Tax due diligence generally refers to the review of previous tax returns as well as informational filings from the current and previous periods. The scope of the audit varies by transaction type. For example, entity acquisitions typically have greater risk than asset purchases, given that taxable target entities may be subject to joint and multiple tax liability of all the participating corporations. Additionally, whether a tax-exempt target is listed in the federal income tax returns that are consolidated as well as the quality of documents relating to transfer pricing in intercompany transactions, are additional factors to be considered.
A review of tax years prior to the year can help determine if the company is in compliance with regulations as well as a few red flags that indicate possible tax abuse. These red flags can include, but aren’t the only ones:
Interviews with the top management are the final step in tax due diligence. These interviews are designed to answer any questions the buyer might have, and to resolve any issues that may have an impact on the deal. This is particularly important when dealing with acquisitions that have complex structures or uncertain tax positions.
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