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What is tax due diligence?

Tax due diligence is a comprehensive process of assessing and analyzing the tax issues associated with a business that is the subject of a potential transaction. The process is designed to identify any tax risks that may affect the value of the company and the future tax situation of investors.
Filip Samczuk
Author of the article
Published
October 3 2024
Reading time
5 minutes
tax due diligence
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 Tax due diligence is particularly important in the context of transactions such as mergers, acquisitions, sales of businesses, as well as restructurings. By carefully verifying tax settlements in light of current regulations, it is possible to avoid unpleasant surprises that could negatively affect a company's post-acquisition financial performance. The tax due diligence process includes analysis of accounting documents, tax returns, invoices and contracts that may affect the company's tax obligations.

The goal is not only to identify potential risks, but also to assess their impact on a company's current and future financial position. Understanding tax risks and tax optimization opportunities is key to making informed investment decisions. Tax due diligence allows you to better understand your tax situation of the audited entity, which is invaluable when negotiating the terms of a deal.

Why is tax due diligence important to investors?

Investors who plan to acquire a company need to be sure that the transaction does not involve hidden tax liabilities. Tax due diligence allows verification that the target company has met its tax obligations in accordance with regulations, minimizing the risk of future disputes with tax authorities. Tax due diligence analyzes, among other things, settlements related to corporate income tax, VAT, personal income tax and social security contributions. Other taxes, such as real estate tax and tax on civil law transactions (PCC), are also verified.

Tax due diligence provides investors with a complete picture of the company's tax situation, which is essential for assessing the profitability of a transaction. It allows them to make rational decisions and effectively negotiate the terms of the purchase. Through this process, investors can identify areas of tax risk that can be mitigated before the transaction is finalized. This, in turn, provides an opportunity to restore legal compliance and reduce additional costs resulting from potential penalties.

Tax due diligence process

The tax due diligence process consists of several key stages that provide a detailed analysis of a company's tax situation. Each of these steps is necessary to identify and assess tax risks. The first step is defining the objectives of the study and planning. In this stage, the scope and main areas to be analyzed are defined. This is followed by the collection of documents and information necessary for the study.

The next step is a thorough analysis of the collected data. All key tax aspects are verified, such as the correctness of settlements, compliance with regulations and possible tax arrears. Specialists also analyze the correctness of the classification of business events in the context of tax law. Based on the analysis, tax risks are identified, and their potential financial and criminal consequences are assessed. Tax specialists also prepare proposals for corrective measures that can be taken to minimize the identified risks.

The final step is to prepare a report on due diligence. This report contains all the key information, conclusions and recommendations on how to mitigate the identified risks. It is a document that forms the basis for further negotiations and investment decisions.

Benefits of tax due diligence for sellers

Tax due diligence is beneficial not only for investors, but also for sellers of businesses. Ordering this study allows sellers to thoroughly prepare for transactions and negotiations with potential buyers. Sellers who order tax due diligence, they can get an independent opinion on their tax situation. This allows them to properly prepare for negotiations and defend the sale price of the business. Due diligence by independent tax advisors can also identify areas that need improvement before the sale.

This gives sellers the opportunity to correct mistakes and avoid potential problems in the future. It is also worth noting that thorough preparation for the transaction through tax due diligence can increase the attractiveness of the company in the eyes of potential buyers. A transparent tax situation and the absence of hidden risks can increase the value of a company.

Differences between tax due diligence and tax review

While tax due diligence and tax review may seem similar, there are key differences between the two processes. Tax due diligence is usually more comprehensive and deals with a multi-year period, while a tax review is more general and usually deals with a specific tax year or a specific issue. Tax due diligence is conducted in the context of transactions such as mergers, acquisitions or business sales. Its purpose is to maximize transparency of the tax area of the entity being examined and to identify and assess risks that may affect the value of the transaction. A tax review, on the other hand, can be performed as part of routine audit activities or in connection with specific activities, such as a tax audit.

This review is aimed at assessing the accuracy of tax settlements for a specific period or for a specific issue. In summary, while both processes are designed to assess a company's tax situation, tax due diligence is more comprehensive and deals with a multi-year period, making it an essential tool in the context of M&A transactions.

Importance of tax due diligence in light of legal changes

The increasing number of tax changes each year requires regular auditing to ensure that the rules for conducting settlements with the tax authorities are up to date. Taxpayers are required to exercise due diligence in their transactions, which requires the creation of an entire process for verifying the course of transactions with a counterparty and the counterparty itself. In the context of dynamically changing tax law, tax due diligence is becoming an essential tool for companies planning transactions. Regular tax audits make it possible to monitor compliance on an ongoing basis and avoid potential tax penalties. In particular, this is important for industries exposed to the activities of the so-called "tax evaders.

tax carousels, such as the fuel, tire, automotive and electronics industries. Negligence in this area can generate large VAT risks and lead to serious financial consequences. Tax due diligence provides companies with confidence that the procedures in place comply with current regulations and minimize the risk of entering into transactions with tax evaders. This allows companies to effectively defend their accounts as an entity unaware of illegal procedures. As a result, regular tax due diligence is key to ensuring the security of tax settlements and maintaining compliance with dynamically changing tax laws.

Summary

Tax due diligence is an indispensable tool in the context of business transactions, which allows an accurate assessment of the tax situation of the company under investigation. The process makes it possible to identify and assess tax risks, which is crucial for making informed investment decisions. The benefits of tax due diligence are multifaceted - both investors and sellers can reap significant benefits. Investors get a full picture of the company's tax situation and can effectively negotiate the terms of the transaction, minimizing the risk of future disputes with tax authorities. Sellers, on the other hand, can thoroughly prepare for the transaction, eliminating potential mistakes and increasing the attractiveness of their company.

In a rapidly changing legal environment, regular tax due diligence is key to ensuring compliance and minimizing tax settlement risks. This allows companies to avoid fiscal penalties and maintain transparency in their tax operations. Ultimately, tax due diligence is an investment in a company's security and financial stability, allowing it to make informed and rational decisions in the context of business transactions.

About the author

Filip Samczuk
For 12 years, he has provided substantive support to entrepreneurs in realizing their dreams of starting or growing a business. He advises on obtaining financing, business development and legal issues. Privately a fanatic of sports, travel and history of the 20th century.

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