Tax obligations for companies go far more than simply paying tax on income. Tax due diligence is an essential element in M&A. It helps determine what liabilities, responsibilities and tax concerns a prospective company faces.
The scope of tax due diligence varies in accordance with the type and size of the company being targeted and also the scope of the transaction, but can include a review of foreign reports (e.g. Form T106) as well as audits that have been conducted in the past or objections, transfer pricing, GST/HST return and related party transactions. It may also include an examination tax preparation due diligence of state and local taxes (e.g. sales and use taxes property taxes and unclaimed property statutes, as well as misclassification of employees as independent contractors).
While it’s easy to focus on the complexity of Federal tax law, there are a variety of state and local taxes that can be hefty and have an impact on the financial health of a company. Moreover, reputational damage often happens when a company is perceived to be tax avoiders, which is difficult to overcome.
In most instances, when a tax return is prepared, it’s mandatory to sign by the preparer the return under penalty of perjury, stating that the return is true and accurate to the best of their knowledge and conviction. However, a recent decision suggests that the IRS may look beyond that standard in reviewing whether the tax preparer has exercised reasonable diligence when preparing a tax return.
