Tax due diligence is not just a risk mitigation exercise. In our experience it creates opportunities to add deal value and streamline transaction timetables.
In our latest Capital Confidence Barometer, Australia and New Zealand survey results indicate that unforeseen tax liabilities keep surprising buyers.
“We have seen many organisations in Australia and New Zealand not properly price in tax risks in transactions by either not doing any tax due diligence or undertaking very limited due diligence when executing major transactions” says Ian Scott, Oceania Leader of EY’s Transaction Tax practice.
In this article, we reveal eight key areas where you can investigate the potential for greater deal value, and outline how you can best prepare for future deals.
Eight ways to unlock value
Tax due diligence adds value in the following areas:
1. Price versus warranties
Understanding the tax profile of a target allows an informed decision to be made regarding whether tax exposures go to deal value or warranties. Where possible, buyers should seek to address known tax issues with price adjustments rather than ignoring them and relying on warranties.
2. Accelerated transaction timetable
Removing tax uncertainty through due diligence can accelerate completion of a transaction. For example, on the sell side, vendor due diligence can assist in running a timely process with multiple parties. On the buy side, addressing tax risks upfront ensures there is sufficient time to resolve exposures.
3. Assessing the target’s tax risks against your own risk profile
Buyers should use tax due diligence to address a target company’s historical tax exposures in light of their own tax governance framework and disclosure requirements, for example, regarding undisclosed tax exposures.
The risk profile of a target may also be influenced by management and/or owners. Tax due diligence enables an assessment of the target’s approach to tax governance and management.
4. Certainty and legislative change
Buyers require certainty regarding the historical and current tax status of a target’s tax positions. This is particularly relevant where retrospective changes to tax law impact the target. These areas should always be reviewed as part of any tax due diligence.
5. It’s not just about income tax
Target companies often have unresolved tax exposures in the areas of GST, employment taxes, stamp duties, Research and Development (R&D) tax incentives and fuel taxes. Tax due diligence is relevant to these areas.
6. Cash flow planning opportunities
Savvy investors will use tax diligence to identify potential cash flow improvement opportunities in areas such as GST, indirect taxes and R&D incentives.
7. If in doubt, do more work
Areas of uncertainty must be reviewed and rectified rather than relying on tax warranties. The ability to rely on a warranty may be limited if an issue was disclosed to the buyer but the buyer undertook insufficient work.
8. Tax warranty insurance
For buyers obtaining tax indemnity and warranty insurance, a complete and appropriate tax due diligence exercise is typically required to enable insurers to consider the potential tax exposures, both known and unknown. An incomplete or limited tax due diligence may not be suitable and may result in risks unable to be covered or additional premiums.
Vendors should consider the benefits of undertaking a vendor tax due diligence at the transaction planning stage to ensure that any work has a sufficiently broad scope to be beneficial to the buyer.
Although the vendor tax due diligence does not typically have the same time pressures as work undertaken by the buyer, vendors may wish to consider the process as a “dry-run” ahead of any buyer due diligence, and work to similar timeframes as they would envisage during the sale process.
Accordingly, settling any outstanding positions and filing any outstanding returns should ideally occur prior to the commencement of the vendor due diligence.
Buyers will want to ensure that the tax due diligence process commences at the same time as any financial due diligence. They will also need to take into account the work undertaken as part of the vendor due diligence, and any ability to rely on such a report.
Buyer’s tax due diligence should be completed well in advance of the negotiation of the tax provisions in the share purchase agreement, in order to ensure that there is no unnecessary rework of the agreement on account of late findings.
Questions to ask yourself:
If you are the vendor, the things which you may wish to consider are:
- Am I ready for a due diligence by a buyer?
- Will I materially increase deal value and/or reduce the time and cost burden of a buyer’s diligence process by conducting a vendor due diligence?
If you are the buyer, you may wish to consider:
- Am I able to rely on a vendor due diligence to reduce cost and time in conducting a buyer due diligence?
- Will I have sufficient time and information to enable adverse findings to be factored into the price?
- Will I have sufficient time to address any risks identified during the tax due diligence in the share purchase agreement?