Tax due diligence is a crucial aspect of M&A that is often ignored. The IRS isn’t able to audit every single company in the United States. Therefore, mistakes and oversights that occur during the M&A processes can lead to heavy penalties. Thankfully, proper preparation and complete documentation can help you avoid these penalties.
In general tax due diligence covers the review of previously filed tax returns as well as the review of current and historical informational filings. The scope of the review depends on the nature of the transaction. For instance, acquisitions of entities, are more likely to expose a company than asset purchases, as companies that are taxable targets could be jointly and severally liable for the tax liabilities of participating corporations. Additional factors include whether an entity that is tax-exempt has been included in the Federal tax returns consolidated and the amount of documentation related to transfer pricing for intercompany transactions.
Reviewing tax returns from prior years will also reveal if the target company complies with applicable regulatory requirements and a number of red flags indicating possible tax abuse. These red flags include, but aren’t the only ones:
Interviews with top managers are the final step in tax due diligence. These interviews are designed to answer any questions that the buyer might have and to clarify any issues that might affect the purchase. This is especially important when buying companies with complicated structures or uncertain tax positions.
