Tax due diligence is an important aspect of M&A which is often neglected. Because the IRS cannot practically conduct an audit of tax compliance for every company in the United States, mistakes or oversights in the M&A process could result in expensive penalties. A thorough and well-organized process will aid in avoiding 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 review varies by transaction type. Acquisitions of entities, for instance, are more likely to expose the company to liability than asset purchases because companies that are taxable targets could be jointly and severally responsible for the tax liabilities of participating corporations. Other factors include whether or not an entity that is tax-exempt has been included in the combined federal tax returns and the amount of documentation related to transfer pricing for intercompany transactions.
A review of tax years will also show whether the target company complies with the applicable regulations and also some red flags that could indicate tax evasion. These red flags may include, but need not be limited to:
The final stage of tax due diligence consists of a series of meetings with top management. These interviews are designed to answer any questions the buyer may have and to clarify any issues that might impact the deal. This is especially important when dealing with acquisitions that have complicated structures or uncertain tax positions.
