The Coronavirus (COVID-19) crisis has presented significant challenges to many companies and the disruption continues to evolve. Undertaking detailed performance and liquidity operational improvement initiatives, streamlining corporate structures, reducing complexity and focusing on core activities are what most businesses are currently looking at. Divesting non-core activities in an effort to focus resources exclusively on core operations has become an important consideration.
Buyers with abundant cash who are looking at effective deployment of their capital have been presented with such opportunities. In the context of extremely subdued industries, assets can come at bargain prices. Distressed asset acquisitions can provide buyers with increased revenue streams through the expansion of a geographic footprint, access to new technologies or other elements within a supply chain and elimination of competition where through the acquisition capacity, technology or other advantages are prevented from falling into the hands of a competitor.
One area that could be overlooked in the excitement of wanting to cease the opportunity quickly is tax due diligence which, if disregarded, can put a buyer at significant risk, particularly with respect to a possible share purchase. In a share purchase, a buyer takes the company "warts and all": all assets and liabilities of the target company remain with the target and the buyer becomes responsible for any liabilities associated with the target including those found after the sale is complete.
A buyer's side tax due diligence seeks, inter alia, to investigate the target's business operations in order to identify actual and potential tax risk exposures arising out of overstated losses, underreported tax liabilities, non-filing exposures, failure to charge taxes, payroll errors, and other tax miscalculations in the various jurisdictions that the target has sufficient business connection to be subject to tax. Failure to understand the tax issues of the target could be a threat to the return of a buyer's investment. Buyers should carefully scrutinise the taxation history of the target to identify any hidden or unforeseen tax liabilities in order to incorporate in their deal negotiations mitigation strategies such as adequate structuring of representations and warranties, consideration of escrows, alternative transaction structures, a purchase price reduction or an earn-out or ceasing an opportunity to require the target to regularise its tax affairs or enter into a voluntary disclosure to mitigate the issue before the purchase takes place.
A seller's side tax due diligence conducted in order to recognise and remedy any major tax issues that could be of a concern to even the most demanding purchaser before launching a formal sale process can also not be understated. A seller's side tax due diligence affords the seller an analysis of its business with a buyer's perspective in mind enabling the seller to anticipate a buyer's view on taxes. A solid "tax health", an attractive business tax policy and tax risk management framework and a clear understanding of key tax negotiating points when it comes to the target could provide the seller with an "upper-hand" during the sale negotiation process.
Whether on the buyer's side or seller's side, the tax due diligence investigation will include, inter alia,
- examining the tax effects of significant, unusual and complex transactions entered into including tactical or uncertain tax positions before the time of the sale or purchase;
- examining past and ongoing tax audits conducted by the tax authorities having regard to what prompted the audit, and whether there is a risk of assessment of additional taxes;
- reviewing all pending disputes and examining formulated response strategies;
- understanding any past voluntary disclosure applications, past and still in-force tax rulings, tax directives;
- analysing the tax returns filling status;
- reviewing the tax risk management framework, including the tax relevant processes;
- where business activities are carried out offshore, reviewing any permanent establishment, transfer pricing and foreign tax credit issues including exchange control compliance;
- analysing business contracts entered into with third and related parties, employment contracts and share incentive plans etc.;
- particularly for international investors, checking whether the target should be purchased directly or through a holding company leveraging the investment; and
- making a prudent decision on whether an asset deal, a share deal or a merger is the suitable option.
A tax due diligence empowers a seller or buyer to make more informed decisions pertaining to the transaction. One can opt for an in-depth tax due diligence analysis or a red flag tax due diligence that only identifies the riskiest or possible deal breaker tax issues.
The old English proverb says there are only two things in life that we can't avoid, death and taxes and when it comes to taxes what you do not know can hurt you. So, whichever side you find yourself in, whether the buyer-side or seller-side, you cannot afford not to be diligent.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.