Importance of Tax Due Diligence

M&A tax risks are rarely visible on the surface. Legacy liabilities, disputed positions and gaps in governance can all sit undetected in a target’s books. A thorough tax services engagement at the due diligence stage is one of the most effective ways to uncover these financial risks before they become the buyer’s liability.

What does tax due diligence involve in M&A transactions?

Tax due diligence is not simply a review of filed returns. It is a highly structured financial investigation into the target’s full tax position covering every material tax type and jurisdiction relevant to the business. The primary objective is to provide buyers with full financial transparency. It ensures the purchase price reflects the true economic value of the target and guarantees no hidden liabilities surface post-closing.

In practice, a comprehensive tax due diligence process scrutinises several critical areas such as the corporate income tax positions, withholding tax obligations, goods and services tax compliance, payroll and employment tax matters and any outstanding or open assessments. Where the target operates across multiple jurisdictions, the scope widens accordingly and the interaction between different tax regimes needs to be understood as part of the overall picture.

The findings from tax due diligence feed directly into deal negotiations. Identified risks are typically addressed through purchase price adjustments, tax indemnities, warranties or escrow arrangements. Without this critical intelligence, a buyer lacks the leverage to negotiate transaction protection and may be exposed to costs that were never factored into the original valuation.

What are the key issues in a tax due diligence project?

1. Identify material tax risks and estimate legacy corporate, withholding, goods and services and employee tax liabilities that impact purchase price and/or will be inherited post-acquisition. These are important to facilitate buyers in negotiating purchase price adjustments, indemnities and warranties, time and financial limits for each deal.
2. Validity of tax incentives and deferred tax assets post-acquisition.
3. Valuation of deferred tax assets post-acquisition.
4. Weaknesses in the governance framework of the targets to identify follow-up actions post-closing.
5. Pillar Two exposure, including whether the target forms part of a multinational group that is or may become subject to the Global Minimum Tax rules following the acquisition.

When conducting M&A tax due diligence, buyers must give special attention to tax incentives and deferred tax assets (DTAs). A target may have received incentive approvals that are conditional on meeting certain thresholds or activities. A change of ownership can trigger a reassessment of eligibility and in some cases the incentive lapses entirely. Similarly, deferred tax assets that appear on the balance sheet may not be realisable post-acquisition if the basis for recognition changes after the deal closes. Both require careful validation rather than assumption.

How should the deal be structured for tax efficiency?

How a deal is structured has a direct bearing on its overall tax cost. The choice of acquisition vehicle, the jurisdiction through which shares are held and the method of acquisition, whether by way of shares or assets, can each result in materially different tax outcomes for the buyer.

Key structuring considerations include:

1. Recommend the tax efficient shareholder or buyer entities for the proposed acquisitions.
2. Estimate the potential tax costs involved in the proposed acquisition, determine purchase price withholding tax applicability and compliance obligations.
3. Negotiate tax warranties and indemnities.
4. Determine the straddle returns preparation process and negotiate the split of taxes for such periods.
5. Assess any tax exposure relating to indirect transfers, purchase price withholding tax and compliance requirements if applicable.
6. Complete the accounts review and purchase price allocations to maximise tax efficiency.

For sellers, please note that Purchase price withholding tax is a potential critical, yet frequently overlooked, cash outflow in cross-border transactions. Where it applies, the buyer may be required to withhold a portion of the purchase price and remit it directly to the relevant tax authority. Failing to account for this at the structuring stage can create unexpected cash flow complications at closing and may affect the effective price paid for the business.

Straddle period returns which span both pre- and post-closing periods also require careful handling. The allocation of taxes between buyer and seller for these periods is a common negotiating point and the approach needs to be agreed and documented clearly in the transaction documents to avoid disputes after completion.

What happens after the deal closes?

Tax due diligence does not conclude when the transaction documents are signed. Once the deal closes, buyers need to address the governance gaps identified during the review, file any outstanding returns, resolve open assessments and integrate the target’s tax compliance processes into the wider group framework. Weaknesses that were flagged during due diligence but not remedied before closing become the buyer’s responsibility to fix, often under time pressure.

Integration planning should begin before the deal closes rather than after. Understanding how the target’s tax profile will interact with the buyer’s existing structure allows the combined entity to operate efficiently from day one rather than spending the first months after closing unwinding positions that could have been addressed earlier.

How can we help?

Navigating the complexities of transaction taxes requires deep technical expertise. Our dedicated team of M&A financial and tax specialists provides comprehensive deal advisory support throughout the transaction lifecycle. We help you protect your investment, optimise deal value and ensure long-term compliance.

If you are evaluating an acquisition or have concerns about the target company’s tax position, speak to our team today. Uncovering and addressing tax exposures at the negotiation stage provides critical leverage. Waiting until after completion forces you to unwind costly mistakes post-closing.