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Tax due diligence is the investigation of the current and future tax liabilities of a company. It is one aspect of the overall due diligence that is conducted in corporate mergers and acquisitions (M&A) when one corporation plans to acquire another or multiple companies plan to merge. The process requires a review of certain tax documents by professionals with expert knowledge of the tax code of the applicable jurisdictions.
Due diligence is a legal standard of care that requires parties to a sale to make every effort to determine the legitimacy of the transaction. The standard puts the onus on the buyer to conduct a thorough investigation to ensure he is receiving the benefit of the bargain. In a corporate context, due diligence satisfies the officers' and directors' fiduciary duty to make sure any decision made will maximize value for existing shareholders. Inadequate due diligence will limit a corporation's legal options if something is later found to be amiss with the transaction, because there will be an aspect of contributory negligence.
A complex M&A transaction will require separate financial, legal, operational, strategic, and tax due diligence investigations of the company being acquired or of both companies in the case of a merger. Each of these areas of investigation will be handled by a team of either accountants or lawyers as well as the acquiring corporation's upper management. Tax due diligence is a particularly exhaustive process and can take months to complete, depending upon the number of jurisdictions at issue in the sale.
The tax team reviews all documents relevant to any sort of tax liability or assessment, including income, sales, employment, capital, and activity taxes. They will request access to tax returns, financial statements, audits, notices of assessments, tax rulings, and memos on tax matters produced by staff and consultants over the years. After a review of the documents in the context of the applicable tax law, the team will produce a written tax due diligence report to management that contains a professional opinion regarding all material tax liabilities and possible future impacts.
Tax consequences can make or break a sale. Even the most straightforward sale requires a substantial investigation that takes into account the different levels of tax liability, such as national, regional, and local. The scope of the investigation becomes exponentially more complex if the corporations involved are located in different countries or when the company being acquired has multiple subsidiaries. Tax due diligence for multinational corporations includes a professional assessment and reconciliation of different accounting standards, treatment of domestic versus foreign sources of income, and tax return filing positions, in addition to the pricing issues involved in the transfer of ownership.