Tax Due Diligence in M&A Transactions

Tax due diligence (TDD) is among the least thought of – and yet one of the most important aspects of M&A. Because the IRS is unable to conduct an audit of all tax-paying company in the United States, mistakes or oversights during the M&A process could result in onerous penalties. Thankfully, proper preparation and thorough documentation can help avoid these penalties.

As a general rule tax due diligence entails 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. For instance, entity acquisitions generally carry a greater risk than asset purchases, due to the fact that taxable target entities may be subject to joint and multiple obligation for taxes of all corporations participating. Also, whether a tax-exempt target has been included in the consolidated federal income tax returns, and the sufficiency of documents relating to transfer pricing in transactions between companies are other factors that can be scrutinized.

The review of prior tax years will also reveal whether the business in question is in compliance with the regulations applicable to it and also a number of warning signs that may indicate tax fraud. These Paperless board meetings red flags could include, but aren’t restricted to:

The final phase of tax due diligence consists of interviews with senior management. The goal of these interviews is to answer any questions that buyers might have, and to provide a clear understanding of any issues that are not resolved that could affect the transaction. This is particularly important when purchasing companies that have complex structures or unclear tax positions.