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Understanding Tax Due Diligence: A Detailed Step Plan 

Tax Due Diligence

Buying a small to medium-sized business in Perth is a considerable undertaking that can propel your business toward new avenues of growth and diversification. But the process has its share of challenges and risks. The vital safeguard against these perils is the comprehensive practice of tax due diligence facilitated by your Perth tax accountant. This process helps your medium-sized business identify and mitigate tax risks, verify tax obligations, and ensure a seamless investment. 

At no time does management want to allocate resources to looking at historical tax positions.  While the penalties and fines for poor tax law compliance can be significant, the drain on management resources during a critical transition can be devastating.  

The Unseen Guardian: Why Tax Due Diligence is Crucial 

Imagine acquiring a company that appears profitable on paper, only to discover later that it has many hidden tax liabilities, leading to unforeseen financial losses. Tax due diligence serves to prevent such scenarios. It is a critical investigation that unveils potential tax liabilities, safeguards against regulatory breaches and protects your business from financial missteps that could lead to litigation or penalties. 

However, tax due diligence isn’t only about risk avoidance; it’s also a strategic exercise. It provides a wealth of insights about the target company’s financial status and operations, guiding informed decisions to drive growth and profitability.  If the tax governance is sound, the financial reporting is also most likely robust.  So, the profits you think you are buying will most likely be actual – ultimately leading to a higher (or more accurate) business value.  

Identifying Major Tax Risks: Case Study Insights 

Let’s consider a hypothetical scenario: Your company, ABC Pty Ltd., is looking to acquire DEF Pty Ltd., a successful technology startup. A detailed review by your Perth tax accountant uncovers some unpaid taxes from a few years back that DEF Pty Ltd. needed to account for in their financials. This due diligence could save ABC Pty Ltd. from unknowingly taking on an unexpected tax liability that could offset the acquisition’s financial benefits. 

This tax liability would then attract penalties and fines beyond the buyer’s control.  And the time spent in managing the ATO can be significant as well.  And the likelihood is that the unpaid taxes from a few years ago have been repeated yearly and possibly built into the forecast profits. 

Ensuring Compliance: A Review of Employment Tax Obligations 

In another example, GHI Pty Ltd. acquired a manufacturing business, unaware that the latter needed to fully comply with the Super Guarantee Levy obligations and Payroll Tax Obligations. This resulted in GHI Pty Ltd. having to shoulder the burden of the overdue superannuation contributions and penalties and charges imposed by the ATO. A thorough review of such obligations as part of tax due diligence would have exposed this liability before the acquisition was finalised. 

The difficulty of unpaid super obligations is that it extends to employee’s remuneration.  The transition of ownership to a new buyer can be unsettling for staff – so to find out they have been historically underpaid can impact staff morale within the acquired company.  

Understanding the GST Profile and Unravelling BAS Disclosure Items 

Consider JKLM Pty Ltd., which acquired a retail business. During the tax due diligence process, their Perth tax accountant noticed discrepancies between the GST reported on the Business Activity Statement (BAS) and the actual financial reports. This revealed that the target company had incorrectly reported its GST, saving JKLM Pty Ltd. from potential future liabilities and fines. 

In that instance, we often find that the business’s turnover is also understated.  So the market share of the acquired business is now less than anticipated. 

The Intricacies of Operating Profits and Taxable Income 

To illustrate, let’s take NOP Pty Ltd., a company that decided to acquire an online advertising business. While the business seemed profitable, a careful review by the Perth tax accountant revealed that the operating profits needed to align with the taxable income due to some aggressive tax positions. This analysis significantly influenced the valuation and the ultimate decision to acquire the business. 

The Importance of Franking Accounts: A Case in Point 

In an acquisition scenario, QRST Pty Ltd., discovered through the tax due diligence process that the target company did not accurately maintain its franking account. This would have impacted the shareholders’ dividends and influenced the company’s valuation, demonstrating the importance of reviewing franking accounts in the due diligence process. 

Given the lack of franking credits available for shareholders the purchased business had a franking additional tax equal to around 30% of the total dividends paid (plus penalties and interest). 

Unveiling Tax Cost Base Setting in Tax Consolidations 

In an example involving a tax consolidation, UVWX Pty Ltd. discovered that the tax cost base settings of the company they were planning to acquire needed to be more favourable. This indicated potential future tax liabilities, influencing UVWX Pty Ltd.’s decision and the final acquisition price. 

The ATO will normally review the tax advice when a company enters the tax consolidation regime.  And the lack of that advice will likely normally indicate that further review and investigation is needed overall.  

Recoupment of Tax Losses: A Hidden Advantage 

Let’s consider a case where YZ Pty Ltd. is interested in acquiring a company that has a history of tax losses. While this might initially seem discouraging, the Perth tax accountant identified that these losses could be recouped against future profits, potentially leading to significant tax savings. This insight enhanced the attractiveness of the acquisition. 

Understanding the Implications of Repair Costs 

In another example, ABCD Pty Ltd. acquired a manufacturing company and found that repair costs had been incorrectly capitalised, impacting the profit and loss statement and the fixed asset valuation. A careful review during tax due diligence would have exposed this issue and influenced the purchase price negotiations. 

Fringe Benefits Tax Exposure and Its Impact 

In the case of EFGH Pty Ltd., the company was considering acquiring a business that provided significant fringe benefits to its employees. Not considering the fringe benefits tax exposure led to unexpected future liabilities. Thorough tax due diligence would have unveiled these costs, providing a more accurate picture of the total cost of acquisition. 

Navigating International Taxes: The Need for Expertise 

Let’s consider a case where IJKL Pty Ltd., a company with primarily domestic operations, decided to acquire a company with international operations. They had to assess the impact of offshore taxation. Their Perth tax accountant is vital in reviewing the target company’s compliance with international tax laws, including transfer pricing regulations, thin capitalisation rules, and controlled foreign corporations (CFC) laws. This due diligence ensures that IJKL Pty Ltd. fully understands the potential international tax liabilities before acquiring. 

Getting a single tax opinion through an international network of tax advisors is important in this instance.  When you are dealing with multiple tax jurisdictions you must have a single point of accountability so that the advice provided is complete.  

Integrating Tax Risks into the Equity Bridge 

Once the tax due diligence is complete, the identified tax risks are integrated into the equity bridge. For example, MNOP Pty Ltd. identified potential tax liabilities during its due diligence process. These were then factored into the equity bridge, impacting the final purchase price and ensuring a fair acquisition. 

The tax due diligence process by the selling management needs to be addressed (especially in the SME sector).  And while it is relatively easy to ignore the tax questions the buyer poses, the direct impact is that the tax exposure the buyer acquires, including senior management time, reduces the purchase price.  

In conclusion, tax due diligence, while complex, forms the bedrock of a successful company acquisition. Partnering with a seasoned Perth tax accountant will provide the necessary expertise and guidance to navigate this multifaceted process, resulting in informed decisions that fuel your business’s growth and success. With meticulous tax due diligence, your business acquisition becomes not just a leap of faith, but a strategic step towards a prosperous future. 

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