Tax Due Diligence in M&A Transactions

importance of digital rooms in due diligence

Tax due diligence is an essential aspect of M&A which is often neglected. Because the IRS is unable to conduct a tax audit of every company in the United States, mistakes or oversights in the M&A process can lead to costly penalties. Fortunately, a proper plan and thorough documentation can help avoid these penalties.

Tax due diligence is typically the review of previous tax returns and informational filings from current and past periods. The scope of the review varies by transaction type. Acquisitions of entities, for instance, are more likely to expose a company than asset purchases since targets that are tax-exempt may be jointly and severally responsible for the taxes of participating corporations. Furthermore, whether a taxable target has been listed on consolidated federal income tax returns and whether there is sufficient documents relating to transfer pricing in intercompany transactions, are additional factors that can be scrutinized.

Reviewing tax returns from prior years will also show whether the business in question is in compliance with any applicable regulatory requirements, as well as some warning signs that may indicate tax abuse. These red flags may include, but aren’t restricted to:

Interviews with top management personnel are the final step in tax due diligence. The aim of these discussions is to answer any questions that buyers may have, and to provide clarity on any issues that might affect the purchase. This is particularly important when purchasing companies that have complex structures or tax positions that are unclear.