Tax due diligence is an essential aspect of M&A that is often left unnoticed. Because the IRS cannot effectively conduct an audit of all tax-paying company in the United States, mistakes or oversights in the M&A process can lead to severe penalties. A well-planned preparation and detailed documentation can aid in avoiding these penalties.
Tax due diligence typically involves the review of previous tax returns, as well as documents pertaining to information from current and previous periods. The scope of the audit varies by transaction type. For instance, entity acquisitions typically have greater risk than asset purchases, due to the fact that taxable target entities may be subject to joint and numerous tax obligations of all corporations participating. Other factors include whether an entity that is tax-exempt has been included in the Federal tax returns consolidated and the amount of documentation that is related to the transfer pricing of intercompany transactions.
Examining tax returns from prior years can also reveal if the company is complying with regulatory requirements, as well as some red flags that may indicate tax evasion. These red flags can include, but aren’t limited to:
Interviews with top managers are the final step in tax due diligence. These interviews are designed to answer any questions a buyer might have and to resolve any issues that may affect the purchase. This is especially important when acquiring companies with complex structures or uncertain tax positions.