Tax Due Diligence in M&A Transactions
Tax due diligence is an essential aspect of M&A that is often ignored. Because the IRS can’t effectively conduct an audit of tax compliance for every company in the United States, mistakes or mistakes made during the M&A process could result in onerous penalties. A thorough and well-organized process will aid in avoiding these penalties.
Tax due diligence is typically the review of previous tax returns as well as informational filings from both current and historic periods. The scope of the review is dependent on the type of transaction. Entity acquisitions, for example, are more likely to expose the company to liability than asset purchases, as taxable target companies may be jointly and severally liable for the taxes of the participating corporations. Other considerations include whether a taxable entity has been included in consolidated federal tax returns and the amount of documentation related to the transfer pricing of intercompany transactions.
Reviewing prior tax years can also reveal if the company is in compliance with the regulations and also some red flags that indicate possible tax abuse. These red flags could include, but not be specific to:
The final phase of tax due diligence consists of a series of meetings with top management. These meetings are designed to answer any questions the buyer might have and to clarify any issues that might impact the deal. This is particularly important in acquisitions that involve complicated structures or uncertain tax positions.
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