Tax due diligence is a crucial aspect of M&A that is often ignored. Because the IRS is unable to conduct an audit of each company in the United States, mistakes or oversights in the M&A process can result in costly penalties. A well-planned preparation and detailed documentation can aid in avoiding these penalties.
Tax due diligence typically involves the examination of tax returns as well as documents pertaining to information from current and historic periods. The scope of the review is dependent on the type of transaction. For example, entity acquisitions typically have greater risk than asset purchases, given that taxable targets may be susceptible to joint and several obligation for taxes of all participating corporations. Other factors include whether or not a taxable entity has been included in unconsolidated federal tax returns as well as the amount of documentation that is related to transfer pricing for intercompany transactions.
A review of tax years prior to the year can reveal whether the company is in compliance with regulations as well as a few red flags indicating possible tax evasion. These red flags include, but are not limited to:
Interviews with top management are the final step in tax due diligence. These meetings are designed to answer any questions that the buyer might have, and to discuss any issues that could have an impact on the deal. This is especially important when acquiring companies with complex structures or uncertain tax positions.
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