What is tax due diligence?
Tax due diligence is a comprehensive examination of the tax position of a company in which an investor is interested. Its main purpose is to identify and assess any tax risks that may be borne by the purchaser following the transaction. Put simply, it is an in-depth analysis designed to answer the question: “Does the company I intend to buy have any hidden tax arrears or liabilities that I will have to pay for?”.
In legal terms, the purchaser of shares or a business often steps into the shoes of their predecessor, inheriting not only the assets but also the company’s tax history. This entails the risk of assuming liability for undisclosed tax liabilities for periods that have not yet become time-barred.
When should tax due diligence be carried out?
This review is an indispensable element of any significant capital transaction. It should be carried out before the final agreement is signed. The most common situations in which tax due diligence is crucial include:
- Mergers and acquisitions (M&A): Both in the case of a share deal and the acquisition of a business or an organised part thereof (asset deal).
- Capital investments: When an investor plans to ‘enter’ a company.
- Restructuring: In the context of reorganisation processes within corporate groups.
- Sale of a business: The review may also be commissioned by the seller (so-called vendor due diligence) to prepare the company for sale and enhance its credibility in the eyes of potential buyers.
In practice, for transactions worth more than several million zlotys, conducting such an audit is standard market practice.
Key areas of the review – what to check?
The scope of tax due diligence should always be tailored to the specific nature of the entity being examined, its industry and the scale of its operations. Typically, the analysis covers a period of 3 to 5 years back, i.e. the period during which tax liabilities have, as a rule, not yet become time-barred.
Checklist of key areas for verification:
| Tax | What should be checked? |
|---|---|
| Corporate Income Tax (CIT) | Correct classification of revenue and tax-deductible costs, correct depreciation calculations, tax losses, and capital gains settlements. |
| Value Added Tax (VAT) | Correctness of the rates applied, timeliness of input tax deduction, correctness of international transactions (intra-Community supply of goods, intra-Community acquisition of goods, export, import of services), settlements under the split payment mechanism. |
| Personal Income Tax (PIT) | Correctness of settlements relating to the remuneration of employees and contractors, including the correct fulfilment of the role of a tax withholder. |
| Civil Law Transactions Tax (PCC) | Verification that all taxable contracts (e.g. loans, sales) have been correctly reported and taxed. |
| Local taxes and charges | Correctness of property tax and vehicle tax settlements. |
| Transfer pricing | Analysis of transactions with related parties, verification of the existence and correctness of transfer pricing documentation, assessment of the arm’s length nature of transaction terms. |
| Other | Liabilities arising from social security contributions (ZUS), excise duty settlements (where applicable), potential ongoing tax proceedings and audits. |
Process and outcome of the review – what to expect?
The tax due diligence process can be divided into several key stages:
- Defining the objectives and scope of the review: Determining which areas and periods will be analysed.
- Gathering documentation: Obtaining the necessary documents from the company under review, such as accounting records, tax returns, contracts and tax rulings.
- Data analysis: Detailed verification of documents by a team of tax advisers and lawyers.
- Identification and assessment of risks: Identifying potential irregularities, estimating their value and the likelihood of their occurrence.
- Report preparation: Drafting of the final document, which marks the culmination of the entire process.
The final tax due diligence report is a key document for the investor. It provides a summary of the identified risks, their potential financial and legal consequences, and includes recommendations for further action. These may include proposals to renegotiate the price, to include appropriate representations and warranties in the sale agreement, or to establish mechanisms to safeguard the buyer’s interests (e.g. through an escrow agreement).
Benefits of conducting tax due diligence
Investing in a professional due diligence review is an expense that pays for itself many times over. The main benefits are:
- Financial security: Minimising the risk of assuming hidden tax liabilities that could place a significant burden on the company after the transaction.
- Better negotiating position: The audit results provide a solid basis for negotiating the purchase price or other terms of the agreement.
- An informed investment decision: Full knowledge of the company’s tax position allows for a rational and well-considered decision on the purchase.
- Identification of optimisation opportunities: The review may also reveal areas where legal tax optimisation measures can be implemented after the transaction is finalised.
In summary, tax due diligence is like a detailed technical inspection of a car before purchasing it. It allows you to look ‘under the bonnet’ of a business, identify potential faults and avoid costly repairs in the future. In the world of business transactions, where millions are often at stake, this is a step that cannot be overlooked.
I specialize in Polish tax law, particularly income taxes, as well as international tax law. My experience includes, among others. providing ongoing tax advisory services, preparing legal and tax opinions, drafting requests for individual interpretations, conducting tax reviews. I gained professional experience in Warsaw law firms.
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