The benefits of a Tax Due Diligence (“TDD”) are often overlooked by purchasers who tend to focus on earnings ratios, future profitability and other non-financial metrics rather than tax. However, with ever changing tax legislation and the Making Tax Digital initiative, companies are increasingly overwhelmed by the time and resource required to efficiently manage the tax compliance process.
Add to that the pressures of navigating the Brexit changes and the COVID-19 pandemic, and it’s pretty easy to let tax affairs slip through the net.
TDD is often viewed by the vendor as an exercise in ‘catching them out’ but in reality it is far less sinister! A TDD is a comprehensive review of the taxes a company is exposed to and allows all parties to understand a company’s tax liabilities and how these should be dealt with in the context of a transaction.
The concept of a TDD is daunting to most however in reality this should only be the case if the process is not managed correctly. Consequently, we have set out some pointers to help you to run your DD process smoothly. We also take a brief look at key tax adjustments which commonly feature in net debt calculations and purchase price discussions.
Preparing for the Tax Due Diligence process
- Assemble appropriate transaction teams. For vendors, this means allocating sufficient staff (or even using external advisors ) to help run the process. The TDD process can be a huge burden for just one person so sharing the load can really de-stress the vendor team and help keep the process moving.
- Sell side teams should populate data rooms as comprehensively as possible before the TDD clock starts ticking. Opening up an empty data room in the first week of a TDD process is every tax advisor’s nightmare. A lack of information early on can significantly delay the review process and often adds pressures to both vendor and purchaser as the completion date approaches. This is where using additional staff/external assistance can really help to lighten the load.
- The buy-side team should aim to assist the vendor with the population of the data room by highlighting requests for key documents as early as possible.
Engaging with Due Diligence teams
Vendors should engage with TDD teams as early as possible. We have all seen the dreaded written ‘information request lists’ which often get batted backwards and forwards between the TDD team and the vendor team. These requests often consume a lot of time and so, whilst we all dread joining a call with a large number of advisors, a TDD conference call can be an efficient and practical method of dealing with queries. I can safely say that at Claritas, we try to keep our TDD team small and do not overwhelm the target management teams on calls!
Vendors should be prepared to ‘bare their tax soul!’ Providing good qualify information upfront helps the TDD team to eliminate potential tax risk areas early on. Being open about tax exposures the company is already aware of helps to progress the TDD and usually creates a better relationship between the sell side and buy side teams, which is helpful when it comes to finding a solution to dealing with any issues.
Purchasers should stay in touch with the TDD team. Weekly or bi-weekly calls (depending on deal timeframe) can often serve as a great platform to discuss the tax risks identified and how to resolve these. Such calls often work well to connect all DD advisors as the cross over in information can help streamline the question-and-answer process with Management.
Closing the DD process
Once the DD process is complete, the TDD team will often work with lawyers to help with drafting legal tax protections for the sale and purchase agreement.
Vendor teams should proactively review the tax deed to confirm that the TDD process accurately reflects any issues identified. Where errors are identified, these should be communicated immediately to avoid delays in buy-side acceptance of the suggested amendments.
Where tax risks are identified, buy-side teams should talk to the vendor to understand whether actions can be taken to mitigate or correct the errors prior to completion.
Finally, RELAX. The DD process is stressful, so take a minute to step back and relax.
Common tax adjustments
As the UK recovers from the COVID-19 pandemic, there has been an increase in M&A activity with deals facing the same type of tax exposures. We have seen the following common tax adjustments for purchase price adjustments:
- Outstanding corporate tax liabilities
- PAYE/NIC arising on transaction bonuses and the exercise of share options
- Corporate tax deductions for the exercise of share options
- Outstanding VAT and PAYE/NIC liabilities following deferrals made under the COVID-19 schemes
- Withholding taxes
And finally, don’t forget pesky interest and penalties!
The TDD process can be stressful if not managed correctly. An efficient TDD process should not interfere with the progress of a transaction if managed correctly, and can easily pay for itself in identifying and removing tax exposures.
