What is Tax Due Diligence? (When Selling)

Tax due diligence (TDD) is a crucial yet often underestimated step in UK mergers, acquisitions, and investment deals. It is best done before the deal goes to market.  

A tax due diligence report is extremely useful for validating financial health, uncovering hidden risks and ensuring a smooth overall deal process. In this blog, I’ll outline what it is, its aims, potential issues and other uses outside of selling a business.

What is Tax Due Diligence? (from the perspective of the seller)

Tax due diligence involves gathering financial and tax information, assessing it carefully and answering potential buyer questions, and addressing any concerns they may have before the transaction begins.

Tax due diligence will also happen during the deal process, with the buyers' tax advisers conducting their own investigation. A sell side tax due diligence exercise can pre-empt the questions the buy side advisers raise and ensure all the data is present and ready for the buyer’s team to review.

From a seller's perspective, tax due diligence can feel daunting, but it is necessary to prepare the business for detailed tax scrutiny by a potential buyer and their advisers.

What does Tax Due Diligence aim to do?

A tax due diligence report will help you identify and resolve potential problems before you go to market. It does so by:

• Identifying risks: uncovering any unpaid/underpaid corporation tax, PAYE/national insurance issues, VAT errors, Capital Gains Tax and anomalies in Stamp Duty Land Tax.
• Assessing compliance: confirming that all statutory filings are up-to-date, employment taxes are correct, and reliefs such as R&D credits are claimed legitimately. This provides reassurance that the business is well-managed.
• Structuring for efficiency: early due diligence can give a good guide of whether to pursue a share or asset purchase, plan deal timing, and assess valuable tax reliefs.
• Supporting deal structuring: findings from tax due diligence can influence how the transaction is structured.
• Building buyer confidence: a transparent and organised approach can increase buyer confidence and improve the likelihood of a smoother transaction. As a result, businesses that are prepared for scrutiny are often perceived as lower risk.

Why is Tax Due Diligence so important?

For a seller, tax due diligence can directly impact the success, value and speed of a transaction. This is because it gives the seller the opportunity to identify and resolve problems before the buyer discovers them.

In addition, a strong tax compliance history can improve buyer confidence and make the business more attractive when negotiating.

If a buyer discovers, (through their own tax due diligence, that VAT filings were incorrect or other tax compliance issues are present, they may:

• Reduce the price they’re willing to pay for the business
• Demand that the issue be fixed before the deal can proceed
• Request indemnities
• Hold money in escrow (temporarily held by a neutral third party until certain conditions are met.)
• Defer consideration and on the condition that all issues are resolved.
• Walk away from the deal completely

Addressing these issues early can help sellers maintain stronger negotiating leverage throughout the transaction and could be the difference between success and failure.

How sellers can prepare for Tax Due Diligence

• Organise Tax Documents: Sellers should ensure that records are complete, accurate, and readily accessible. This typically includes tax returns, VAT filings, payroll records, and supporting calculations.
• Conduct a Pre-Sale Tax Review: many businesses undertake a pre-sale tax review to identify issues before buyers begin their own due diligence.
• Address Outstanding Liabilities: where possible, sellers should settle outstanding liabilities or provide clear explanations for unresolved matters, as transparency is viewed more positively than concealing issues.
• Work with Professional Advisors: experienced tax advisers can help sellers prepare disclosures and respond effectively to any tax issues.
• Prepare a Data Room: a well-organised virtual data room (a secure online space used to share confidential business documents during a sale) can streamline the due diligence process. By providing documents in a structured format, buyers can review them more easily.

Common issues during Tax Due Diligence

It’s normal for businesses to encounter issues during the due diligence process. That’s exactly what it’s designed to identify before they can jeopardise a deal. The benefit is that you can address them before you even go to market.

Common issues that crop up during Tax Due Diligence include:

• Missing or Incomplete Tax Records
• VAT and Indirect Tax Errors
• Payroll and Employment Tax Risks
• Historic Tax Liabilities
• R&D Tax Relief eligibility or compliance concerns
• Restructuring work and share transactions completed without HMRC clearance, tax advice and legal advice.

When else is Tax Due Diligence needed?

Tax due diligence is not only required when selling a business but can also be necessary in a range of other commercial situations.

• It’s commonly carried out whenever there’s a significant change in ownership, structure, or investment in a business.
• TDD is therefore essential in both mergers and acquisitions to identify potential tax risks before the deal is finalised.

This helps both parties understand the target company's tax position and avoid future disputes.

Contact us if you need assistance with TDD

A tax due diligence report provides sellers with a detailed, clear, and decision-ready view of a company’s tax position and risk profile.  

If your TDD report is clear and open to adjustment, it will help towards an efficient and successful transaction. If it is incomplete, poor quality, or missing altogether, your deal could be at risk of delay, friction, or even total collapse.

That’s why understanding tax due diligence is crucial when selling your business (or its parts).

If you’re thinking of selling your business and have any questions about Tax Due Diligence, or any other part of the process, reach out today.