Tax due diligence (TDD) is among the least studied – but yet most critical – aspects of M&A. The IRS isn’t able to audit every single company in the United States. Therefore, mistakes and oversights that occur during the M&A procedures could result in severe penalties. Fortunately, a proper plan and detailed documentation can reduce these penalties.
Tax due diligence is generally the review of previous tax returns as well as informational filings from current as well as past years. The scope of the audit differs according to the type of transaction. Acquisitions of entities, for instance are more likely to expose an organization than asset acquisitions because targets that are tax-exempt may be jointly and severally liable for the taxes of the participating corporations. Moreover, whether a taxable target has been listed on the federal income tax returns that are consolidated and whether there is sufficient the documentation on transfer pricing for intercompany transactions are other factors that can be scrutinized.
Reviewing prior tax years will also reveal if the company is in compliance with any applicable regulatory requirements, as well as a number of warning signs that may indicate tax fraud. These red flags can include, but are not limited to:
The final stage of tax due diligence is comprised of a series of meetings with top management. These meetings are designed to answer any queries the buyer may have and to resolve any issues that may impact the deal. This is especially important when purchasing companies with complex structures or tax positions that are unclear.