There are two types of tax due diligence – sell-side and buy-side. In the context of tax due diligence, transfer pricing involves many risks. Buyers need to be protected against downside risks from a business in which they have invested significant time and capital. Even if a buyer does not seek recourse against the potential risks identified, tax due diligence allows a buyer to make an informed decision and decide whether or not to accept it. An efficient process does not affect the overall progress of the transaction and can be cost-effective by eliminating potential negative impacts on the financial models on which the view of the transaction is based. The benefits of tax due diligence can far outweigh the costs. Exaggerated NOLs, understated tax liabilities, risks of non-reporting, non-collection of sales or use tax, and payroll tax errors can lead to potentially significant risks. If a buyer is not aware of and protected against these risks, the potential risks involved may negatively impact the expected return or profit of a transaction projected in the financial models. Tax due diligence includes not only income tax, but also sales and use taxes, payroll taxes, property taxes, unclaimed and abandoned property (escheat), and the classification of independent contractors and employees. If the target companies have foreign subsidiaries or foreign parent companies, tax due diligence may include a review of transfer pricing and foreign tax credits. The process includes reading tax returns (for all types of taxes) and non-tax documents, as well as inquiries to the target company`s management and tax advisors. Reading non-tax documents, such as minutes of board meetings or LLC general meetings, financial statements and related footnotes, stock ownership plans, and employment contracts, can lead to the discovery of a variety of potential tax issues, including past ownership changes that affect a company`s ability to use net operating loss carry-forwards against profits.

future, aggressive or uncertain tax positions. and deferred compensation and golden parachutes. The target conducts sell-side due diligence to identify and address key tax risks before inviting potential buyers. The basic and early exercise of tax due diligence is to confirm that the target company complies with all state tax regulations. This may include a review of all applicable tax types such as corporate tax, sales/VAT, excise duty, customs duties, employee tax, and other specific taxes that apply to the target company. Taxes are one of the most important elements that determine the overall profitability of a business. It is so important that it has its own place in the company`s financial report in the name of things like net profit before tax, net profit after tax, deferred tax, etc. Therefore, it goes without saying that the tax aspect should not be ignored in the due diligence of mergers and acquisitions. So what does a buyer pay attention to in tax due diligence? There are five common areas – Tax due diligence is a comprehensive examination of the different types of taxes that can be imposed on a particular business, as well as the different tax jurisdictions where it may have sufficient connection to be subject to such taxes. The goal of tax due diligence, which is most often used on the buying side of a transaction, is to uncover significant potential tax risks. Unlike preparing the annual tax return, tax due diligence is less about relatively small missed items or miscalculations (for example, if an unauthorized deduction for meals and entertainment would have been $10,000 instead of $5,000). While the materiality threshold may change depending on the value of the transaction (or the target if the transaction involves less than 100% of equity), an amount that would affect a buyer`s negotiations or decision to proceed with a transaction is generally higher than the amount that would affect a tax preparer.

Tax due diligence is usually carried out after a preliminary analysis. After liking the idea of acquiring a target company based on its business model, financial stability, sustainability, market presence, management, and culture, the buyer begins to dig for tax risks. Corporations taxed under Subchapter C of the Internal Revenue Code pay corporate income tax on net income. As a result, the tax due diligence of these companies requires a review to determine whether it is possible for the IRS (or any state or local tax authority) to assess the companies` additional tax liabilities (and therefore interest and penalties) resulting from incorrect tax errors or positions discovered during the audit. Unlike «C» corporations, partnerships and «S» corporations are «flow-through» corporations, meaning they do not pay corporate-level income tax on their net income. Instead, the net profit is distributed to partners, LLC members, or S Corporation shareholders and taxed to those owners (or higher levels in a tiered structure). Although, theoretically, not all tax audit adjustments made in the pre-transaction periods should be the responsibility of the buyer, the need for income tax due diligence is not completely excluded. At the time of the IPO, DD`s mission is to ensure the completeness and accuracy of the prospectus.

In addition, the issuing companion aims in particular to free himself from the accusation of gross negligence in the event of litigation by referring to DD (due diligence defense). Finally, the DD serves as the bank`s recourse against the experts used, insofar as they did not act prudently during the audit and thus engaged the bank`s liability. Both are extremely useful to different parties to mergers or acquisitions. In this article, we will discuss due diligence on the buyer`s side. Due diligence must be considered in the context of U.S. sales law, according to which the buyer must be cautious (Latin caveat emptor). The term due diligence originates from the U.S. Capital Markets and Investor Protection Act (securities laws) and refers to liability regulations for those involved in securities trading.

The Securities Act (SA) of 1933 regulates the initial issue of securities. Pursuant to Section 11(a) SA 1933, the auditor is also liable to the original purchasers of a security offered to the public for losses incurred by them as a result of that security if the registration information with the U.S. Securities and Exchange Commission (SEC) contained misleading information (prospectus liability). The so-called due diligence defence offers the auditor the opportunity to avoid this liability if he can prove that he or she performed the audit with due diligence (= due diligence). From this discussion, we can conclude that the benefits of tax due diligence may far outweigh its cost. Tax due diligence can easily identify potential risk exposures arising from overstated losses, under-reported tax liabilities, non-reporting exposures, failure to charge taxes, payroll errors and other tax miscalculations. Suppose these risks are not detected during the due diligence process. In this case, at some point in the future, it will have a negative impact on the cash flow, profitability and reputation of the acquirer. If there are irreversible tax risks, it is in the buyer`s interest to move away from the business, no matter how tempting it may be. Tax due diligence is an in-depth investigation of the different types of taxes affecting the target company. If an acquirer is considering a merger or acquisition, it is important that they recognize a significant tax risk for the target company. The word «significant» is very important here.

A target company that generates a net profit of $100,000 will not be significantly affected by a potential future tax liability of $500. However, if the tax payable is $10,000, this exposure will certainly influence the buyer`s decision. Thus, tax due diligence takes into account liabilities that have a decisive influence on the profitability of the target company. The need for tax due diligence is sometimes overlooked by buyers who focus on profit quality analysis or other non-financial due diligence, but has never been greater. The increasing complexity of federal, state, and local tax laws, the myriad of corporate taxes, aggressive (and sometimes evasive) tax reduction or deferral strategies used by taxpayers, rigorous enforcement by tax authorities, and the broadening of the bases of the state tax nexus by state legislators increase the risk of an investment made without proper tax audit. Becomes.