If you are considering buying a company, you need to know what you’re buying. Questions you need to consider are:

• What risks and liabilities would you inherit?
• How can those risks be quantified and minimised?
• What price are you willing to pay for the shares, taking those matters into account?

The process is equally important for vendors. They would commonly consider:

• What are the limitations of the indemnities they are willing to give to the purchaser?
• What is the company really worth, and should the consideration be paid immediately, in instalments, or when the company meets certain targets after sale (or a mixture of all three)?
• How much exposure would they have to any issues that come to light after the sale, particularly if this has been triggered by an action or omission of the purchaser and it reduces the amount of money they will receive for their shares?

The due diligence process seeks to answer these questions.

The sale and purchase agreement (SPA) is the key document which sets out the terms of the agreement between the parties. A separate section of the SPA is usually devoted to tax warranties and indemnities and a review of these would normally form an important part of the due diligence process. The SPA is a legal contract and is worded accordingly, frequently referencing sections of the legislation. Understanding the meaning behind the terminology and their wider implications post- sale is crucial and should be undertaken by tax experts.

What are the most common issues arising when carrying out tax due diligence work?

Whilst each case is different, and brings specific issues, there are a number of areas we commonly see when carrying out tax due diligence work, which are set out below. This list is not intended to be exhaustive and in this article we have focused mainly on corporate tax areas, as opposed to payroll and VAT. Each area of taxation is usually reviewed separately as part of the due diligence process.

Corporate tax issues

• Implications arising directly from the sale, particularly where the target company leaves an existing group and joins a new one. Examples of potential issues are: a claw back of SLDT group relief where the transferee company leaves a group within 3 years of the transfer; de-grouping charges; the sale triggering existing EMI ‘exit only’ options (with the question then being who gets benefit of the corporation tax relief, the buyer or the seller?); the impact on the number of associated companies and the potential acceleration of corporation tax quarterly instalment payments; considering pre-entry capital gains and losses limitations and whether any other losses carried forward within the target company could be restricted after purchase.
• Research and development (‘R&D’) allowances: what allowances have been claimed in the past and what is the risk of HMRC denying both future and past relief? This is particularly topical in view of the recent crackdown by HMRC on R&D claims. Due to the generous nature of the relief, R&D allowances frequently make up a large proportion of a company’s tax savings.
• Overdrawn participator’s loan accounts where there has been ‘bed and breakfasting’ in the past, leading to potentially undeclared and unpaid ‘S455 tax’ liabilities for the company.
• Understanding the base costs of assets acquired within the company and the likely ‘hidden’ tax costs if sold at current market value, and ensuring that this is fairly reflected in the deferred tax provision in the completion accounts.
• Issues with loans from connected parties that have been written off, where tax neutral treatment has been claimed inappropriately (for example where the loans were not made on a commercial basis) meaning that corporation tax has been underpaid.

VAT issues

• Ensuring you have a full history of the business’s dealings with HMRC. This includes any assessments raised, agreements made or even finding the acknowledgement of an option to tax (now no longer issued by HMRC).
• Finding that the business has not recognised exempt income (i.e. not done partial exemption calculations to see if the amount of VAT recoverable is restricted) or not appreciating the way that the Capital Goods Scheme (CGS) works and can impact on their VAT recoveries. Such is the way the CGS works this can result in a business having to repay VAT that was originally claimed by predecessor business that acquired the capital asset.
• Finally, where there are associated businesses, an absence of agreements/contracts/leases to clearly detail who is supplying what to who and therefore being able to establish the correct VAT treatment. For example, if there is no proper lease in place between a landlord and tenant then HMRC will take the view that the landlord is not operating a rental business that could benefit from Transfer of a Going Concern (TOGC) treatment.

Payroll and general issues

• ‘IR35 issues’- where contractors have been treated in the past as self-employed but there is a significant risk that HMRC would deem them to be employees, meaning that the target company could be liable for underpaid PAYE and National Insurance liabilities.
• Historical compliance issues- such as whether Employment Related Security and ATED reporting has been correctly carried out, as well as whether the usual corporation tax, PAYE and VAT returns have been filed and payments made on time. If not, the potential penalties and late payment interest charges need to be quantified.

Why is professional advice needed?

Buying a company can be a difficult and stressful procedure for both the purchaser and the vendor. Due diligence is a complicated process and only professionals with a comprehensive understanding of the tax legislation are in a position to effectively advice their clients on the tax implications of the deal. A professional tax review plays a vital role in the due diligence process, seeking to uncover any significant problems and potential liabilities that need to be considered by both parties, and to prevent any unintended consequences arising after the deal has been agreed.

If you are considering buying or selling a company and you would like advice and assistance please get in touch.