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:
- A tax risk identified is already reflected in the IFRS/US GAAP financials as a deferred tax liability (DTL) e.g. in the case of provisions or impairments. Depending on the mechanism how the purchase price is defined and without close involvement of the tax, financial and legal teams, an intended purchase price adjustment might in effect be included twice (“double counting”) or not at all;
- Deferred tax assets (DTAs) might be recognized with respect to tax losses in the IFRS/US GAAP financials. Depending on the nature of such losses and the mechanism in the SPA, this can result in an increase of the purchase price, which may or may not be appropriate. Care also needs to be taken when tax risks are identified that would reduce such tax losses, hence also reducing the value of the DTA;
- The definition of taxes in the SPA usually does not cover deferred taxes. Whether this is appropriate needs to be analyzed carefully to make sure that all tax risks (with or without corresponding DTL) are covered by tax indemnities and warranties as intended.