Any merger and acquisition transaction has to be planned and executed carefully; therefore, before closing a deal and making more informed decisions, the buyer normally carries out certain agreed upon procedures to assess the deal from commercial, financial, tax and legal standpoints. Beside important issues, this includes a spectrum of tax and regulatory issues such us exchange control, income taxes, indirect taxes and capital market regulations.

The agreed upon procedures are normally described as a ‘due diligence exercise’. The expiration ‘due diligence’ is not defined by any statute, nor is there any legal binding to carry out the same; on the contrary, it is a creation of conventional practices.

Although due diligence is not something that will solve all problems against investment failures, it provides the potential buyer with relevant information and business/targets proposed to be acquired and helps manage associated risks.

Tax due diligence – significance

Tax is one of the material and unavoidable costs. Hence, tax due diligence plays a significant role in M&A decision making, though tax is normally not the primary consideration in the context of M & A transaction.

Conventionally, tax due diligence is carried out to understand the tax profile of the target and to uncover and quantify tax exposures. However, tax due diligence also encompasses identifying any tax upside (potential tax benefits that are not being claimed) which may be available with the target. It also assists in identifying and developing a suitable acquisition structure for the deal in question.

In practice, the most common form for tax risk mitigation is through tax warranties and indemnities in the agreement. The buyer needs to be balanced while negotiating for this tax protection to ensure that it does not impact the commerciality of the transaction for the seller.

To summarize, a tax due diligence is normally carried out to:

• Validate the representation made by the seller at the time of pre-deal negotiations.
• Validate the assumptions made by the buyer in valuing the target.
• Identify any material tax exposures that may be residing with the target.
• Identify any material upsides (potential tax benefits that are not being claimed/envisaged by the targets)
• Structure the deal in a tax-efficient manner.