Tax due diligence is a crucial aspect of M&A which is often neglected. The IRS can’t audit every firm in the United States. Therefore, mistakes and oversights made during the M&A procedures could result in significant penalties. Fortunately, a proper plan and complete documentation can help you avoid these penalties.
As a general rule tax due diligence covers the review of previously filed tax returns, as well as current and historical informational filings. The scope of the audit varies by transaction type. For instance, acquisitions of entities generally carry a greater risk than asset purchases, given that taxable targets may be subject to joint and multiple obligation for taxes of all participating corporations. Additionally, whether a tax-exempt target is listed in the consolidated federal income tax returns and whether it has the proper documentation regarding transfer pricing related to intercompany transactions, are additional factors that may be reviewed.
The review of prior tax years will also determine if the company is in compliance with the applicable regulations, as well as a number of red flags indicating possible tax abuse. These red flags include but aren’t restricted to:
Interviews with the top management are the final step in tax due diligence. These interviews are designed to answer any queries the buyer might have and to identify any issues that could have an impact on the deal. This is particularly important in acquisitions involving complex structures or unclear tax positions.
