Tax Due

Diligence
April 2015

Kingston Smith’s Mergers & Acquisitions can be deducted, or whether any purchase Limited due diligence
(M&A) tax team is a specialist practice that monies should be held in escrow for the Purchasers may decide that an exercise
helps clients review and manage the tax risks same purpose. Further, tax matters relating with a more limited coverage is appropriate.
associated with acquisitions and disposals of to the target which are of concern can lead to If so we can adjust our scope to focus on
a business. a reduction in the price being offered and, in the following:
more extreme cases, a total restructuring of
Why do I need tax due diligence? the deal (for example from a share purchase • Looking at more recent accounting periods
The purchase of a company or business, can to a business purchase) or a withdrawal from only and not looking at the previous four
mean that the purchaser inherits exposure the transaction altogether. years for example.
to tax positions relating to periods prior to, • Simply reviewing information provided
or events occurring before, the purchaser Tax due diligence is therefore an important by the vendor in response to our due
obtains control. The purposes of tax due part of the purchase process and can help diligence questionnaire rather than a full
diligence is for a professional firm to review mitigate the purchaser’s risk and provide examination of underlying returns and
the tax affairs of the target in order to give protection in relation to tax liabilities that computations.
the purchaser comfort as to the tax status of may accompany the target. It also allows a
the intended target. purchaser to identify the most favourable Where limited due diligence exposes areas
structure for the transaction optimising of risk we can recommend a targeted
The benefit of tax due diligence benefits and unlocking previously unclaimed investigation into these areas. Where this
Tax due diligence is not the only way of dealing tax recoveries. detail is not within the agreed scope, we can
with a target’s tax position and such an bring this to your attention.
exercise may have an impact on the following: Many businesses are now looking
internationally to fulfil future growth Targeted due diligence
• The scope of the warranties and in strategies and buyers need to be aware of It may be that the target company is
particular warranties which are directed both domestic and international tax issues. quite ‘young’ and the need for detailed
at the vendor providing more information Utilising KS’s international structure (KSi) due diligence is not so critical. However,
about particular areas of concern. international aspects can be considered as there may be a specific area of concern,
• The inclusion of any indemnities specific part of the due diligence assignment. for example the correct status of contract
to any area of tax where the due diligence workers. In this situation it may be
has revealed that there is a specific How much tax due diligence do I need? appropriate for a purchaser to focus on this
risk. For example, if the target engages The level of tax due diligence work can be area alone.
a number of contractors there may be tailored to suit the individual requirements
concerns as to whether these workers of a purchaser, be it a full scope review or a In all cases our draft due diligence report
may in reality be employees with the PAYE more limited/targetted analysis. will be discussed with the purchaser
and national insurance consequences and their legal advisers to consider the
that follow. Additional indemnities may In broad terms the scope of tax due impact on the deal structure and the
be targeted at this particular area to diligence can be divided into the following documentation as well as whether any
ensure that the purchaser is fully covered three categories: further investigation is required.
in case a recovery of any tax from the
vendor is required. Full due diligence Is this just for purchasers?
This would provide an in depth review, Usually, due diligence is an exercise
Whilst the warranties and indemnities may outlining the risks and quantify any conducted on behalf of the purchaser during
provide the purchaser with a mechanism contingent liabilities and provide advice as a sale process. If issues are identified there
for recovering any unprovided tax liabilities, to how these may be managed. This would can be limited time to deal with them and
it undoubtedly will take time and money usually involve reviewing most tax issues possible price impacts.
to go through the process. The tax due for the previous four accounting periods
diligence process can also indicate how or financial years, plus the current year or One way of addressing this is for our team
the consideration is structured, in terms of period. Specific exclusions may be discussed to conduct a pre-sale due diligence exercise
deferred consideration from which a tax claim and included within our engagement terms. on behalf of the vendor. This would need
Tax Due Diligence

to be at an early stage, probably where a • Reviewing entrepreneurs’ relief or Our fees are based on the agreed
decision to sell has been made or where substantial shareholding exemption to scope of the assignment and the
there is a chance that a realistic offer may ensure that on a sale these valuable technical staff required to deal with the
arise. The point of such an exercise is to reliefs may be secured. complexity of each project.
identify matters that can be dealt to make • Considering the incentivisation and
the actual due diligence process less retention of key employees so that they It should be acknowledged that limiting
problematic such as: stay motivated to achieve the same goal. the scope of tax due diligence increases
the potential risk of unexpected tax
• Closing HMRC enquiries. Summary liabilities materialising, giving the
• Keeping a file of important tax documents Tax due diligence is an important component associated problems regarding recovery
such as dispensations, tax clearances, of the overall acquisition or sale process. from the vendor. If a client chooses to
transfer pricing policies and agreements We work closely with our Corporate Finance limit the scope of any tax due diligence
with HMRC on specific VAT matters. team to provide a seamless service that no responsibility can be taken by Kingston
• Ensuring dispensations and HMRC encompasses the commercial, financial and Smith LLP for any matters that are not
forms/agreements are in place and tax considerations of the deal, for the benefit discovered as a result of this limitation
correctly filed. of the client. of scope.

Case studies therefore not have qualified for the identified that the company could be
• EMI options advantageous tax reliefs that an EMI deemed a UK resident company as
Recently we undertook a review scheme would have secured. A large there was a significant concern that it
of a company which had granted PAYE charge would therefore have was managed and controlled from the
Enterprise Management Incentive been due within a month of sale. UK. If UK resident then all the historic
(EMI) options to employees. On profits were liable to UK corporation tax
review it was discovered that the As this was spotted early we were subject to overseas tax paid.
structure of the deal would not able to change the mechanics of
enable the EMI options to be the deal so that the options could By identifying this point in advance this
exercised due to poorly drafted be exercised under the EMI rules to enabled us to change the mechanics
conditions within the option avoid this PAYE charge. of the deal and avoid acquiring the
agreements. ‘history’ of this overseas entity and the
• Overseas company potential corporation tax risk for the
If the share options were not A UK target company had a Hong earlier years.
exercised they would have been Kong subsidiary, after undertaking
deemed unapproved options and the due diligence process we

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LLP is a member of KS International.
© Kingston Smith LLP 2015