Tax due diligence is an essential aspect of M&A that is often left unnoticed. The IRS can’t audit every company in the United States. Therefore, mistakes and oversights made in the M&A procedures could result in heavy penalties. A well-planned and meticulously documented process can aid in avoiding these penalties.
In general tax due diligence entails the review of previously filed tax returns as well, as well as current and historical informational filings. The scope of the audit varies by transaction type. For example, entity acquisitions generally carry a greater risk than asset purchases, due to the fact that tax-exempt entities could be susceptible to joint and several tax liability of all corporations participating. Additionally, whether a tax-exempt target is included in the federal income tax returns that are consolidated and whether there is sufficient documentation regarding transfer pricing related to intercompany transactions are additional aspects that could be examined.
A review of tax years will also show whether the company is in compliance with the regulations applicable to it and a number of warning signs that may indicate tax fraud. These red flags could include, but need not be limited to:
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 crucial in transactions that involve complex structures or unclear tax positions.