Generally, tax due diligence is the process of examining a company’s tax profile and history to identify potential tax liabilities relating to pre-acquisition tax periods of the Target that could be assessed by tax authorities post-acquisition.
While specific goals vary among specific Buyers and, sometimes, to a large degree between types of Buyers, tax due diligence generally serves to achieve similar core objectives for all Buyers. The two main categories of Buyers are strategic Buyers (e.g., operating companies) and financial Buyers (e.g., private equity firms).
A common goal among Buyers is to pay the lowest price possible for the Target or Target’s assets in order to maximize the Buyer’s return on investment. Accordingly, the Buyer needs a complete picture of the Target’s liabilities, including potential tax liabilities, which could reduce the Target’s value in the Buyer’s hands. Knowing whether potential tax exposures exist early on in the deal process better equips the Buyer to effectively negotiate key terms of the deal, including the purchase price, and mitigate risk.
Techniques that a Buyer can use to mitigate risk related to tax exposure include:
For publicly traded Targets, where Buyer generally has no post-acquisition recourse against the Seller since tax indemnities are not provided, purchase price holdbacks and escrows are not a feasible risk mitigation tool. In such case, and in cases where traditional remedial measures are not practical or desirable, Representations and Warranty Insurance (“Reps & Warranty Insurance”) is commonly used by Buyers to mitigate tax risks.
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