The main objective of a tax due diligence exercise during a merger or acquisition is to identify potential (cash) tax risks and to appropriately reflect these in the negotiations. However, where the target group and/or the buyer prepare accounts under IFRS/US GAAP, tax accounting considerations also become important.
Identifying tax risks and making sure these are appropriately reflected in the negotiations are the most important objectives of a tax due diligence. This could mean that identified tax risks are deducted from the purchase price or appropriate indemnities are included in the sales and purchase agreement (SPA) for such risks. Further, it also allows the acquirer to obtain first important insights into the tax function and attributes of the target group relevant for structuring and integration considerations.
The target group’s tax positions, deferred taxes and tax disclosures in the IFRS/US GAAP accounts should already be considered in the due diligence to ensure a complete view of the target. This is not only important from a complete risk identification perspective but also forms the basis to understand the main drivers of the target group’s effective tax rate (ETR). This information is very important for structuring and integration considerations. Understanding the current and deferred tax impacts included in the financial statements already at the due diligence phase will also make for better negotiations of the SPA, for instance when discussing the purchase price adjustment mechanism and reflecting specific (current and/or deferred) tax positions in the closing accounts.
In the heat of M&A and due diligence projects, where information and time available for analysis are often limited, the potential impact and interaction of deferred taxes are often not adequately analyzed. Moreover, it does not help that deferred taxes have an interdisciplinary nature in terms of being based both in tax and accounting, and as a result, responsibilities in tax and finance functions are often unclear.
This can potentially lead to situations such as:
On the contrary, information in the target company’s/group’s (consolidated) IFRS/US GAAP financial statements on tax positions can also be leveraged in tax due diligence projects, especially at an early stage when detailed information may not yet be available. Ears should prick up if something seems remiss in certain tax positions as this could be an indication that something larger looms underneath.
Examples of such useful information include:
It is clear that tax accounting considerations are important in tax due diligence exercises and the close involvement of the tax, financial and legal teams of an M&A project is a good idea in order to make sure that tax risks are appropriately reflected in the negotiations and the SPA. Further, tax accounting information can be used at an early stage of the project to get important first insights into the target group’s tax affairs and positions. By including tax accounting considerations early in an M&A project, ETR drivers are better understood and can form the basis for further analysis in the structuring and integration phases of such projects.