Tax due diligence is an important aspect of M&A that is often left unnoticed. Because the IRS can’t effectively conduct a tax audit of every company in the United States, mistakes or oversights during the M&A process could lead to onerous penalties. A thorough and well-organized process can help you avoid these penalties.
In general tax due diligence is the review of prior filed tax returns as well, as well as current and historical informational filings. The scope of the audit varies depending on the type of transaction. For instance, acquisitions of entities, are more likely to expose the company to liability than asset acquisitions because targets that are tax-exempt may be jointly and severally responsible for the tax liabilities of the participating corporations. Additionally, whether a tax-exempt target has been listed on the consolidated federal income tax returns and whether it has the proper the documentation on transfer pricing for intercompany transactions are additional factors that may be reviewed.
The review of prior tax years will also reveal whether the company is in compliance with any applicable regulatory requirements and a number of red flags that could indicate tax abuse. These red flags may include, but are not specific to:
The final stage of tax due diligence is comprised of interviews with senior management. The aim of these discussions is to answer any questions that the buyer might have, and to provide clarity on any issues that might influence the sale. This is especially crucial in acquisitions involving complex structures or unclear tax positions.