TAX DUE DILIGENCE

Definition

Tax due diligence is a thorough investigation of different types of taxes that affect the target
company.
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Tax due diligence is a comprehensive examination of the different types of taxes that may be
imposed upon a particular business, as well as the various taxing jurisdictions in which it may
have sufficient connection to be subject to such taxes. 
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Objective and purpose

The goal of tax due diligence is to uncover significant potential tax exposures.
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Due diligence in regard to tax liability includes a review of all taxes the company is required to
pay and ensuring their proper calculation with no intention of under-reporting of taxes.
Additionally, verify the status of any tax-related case pending with the tax authorities.
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Benefit and Risk of due diligence in a business organization

A tax due diligence can easily identify potential risk exposures arising out of overstated losses,
underreported tax liabilities, non-filing exposures, failure to charge taxes, payroll errors, and
other tax miscalculations. If these risks go undetected during the due diligence process, it will
create a negative impact on cash flow, profitability and reputation of the company at some
point of time in future
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Scope (Areas Covered) of Due Diligence

 TAX COMPLIANCE - Tax due diligence is to confirm that the company is adhering to
all government tax compliance. This may include a review of all applicable types of taxes
such as – corporation tax, sales/ value-added tax, excise tax, customs duties, employee
tax and other specific taxes applicable to the company.
 TAX CREDITS - There can be two ways in which the target company can have a tax
liability in this area. Either it has miscalculated these credits or it has wrongly claimed
them. Both cases will give rise to tax liabilities and heavy penalties in the future.
 TRANSFER PRICING - In most transactions, the exchange of goods/ services is
between sister-concerns under the same parent company. Furthermore, these
companies are under different jurisdictions and are operating under different tax laws.
This carries a risk of over calculating taxes, double counting, or not charging taxes
where applicable. In order to avoid tax liabilities arising out of these transactions, the
acquirer must look into the company’s transfer pricing agreements and it must also
analyze all such past transactions
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Tax diligence covers not only income taxes, but also sales and use taxes, payroll and
employment taxes, property taxes, unclaimed and abandoned property (escheatment), and
independent contractor vs. employee classification. Where target companies have either foreign
subsidiaries or foreign parents, tax due diligence may include a review of transfer pricing and
foreign tax credit issues. The process includes reading tax returns (for all types of taxes) and
non-tax documents, and making inquiries of management and the target's tax advisors.
Reading non-tax documents, such as minutes of corporate board meetings or LLC member
meetings, financial statements and related footnotes, equity compensation plans, and
employment contracts can lead to discovery of a variety of potential tax issues, including prior
ownership changes that affect a corporation's ability to utilize net operating loss carry forwards
against future income, aggressive or uncertain tax positions taken, and deferred compensation
and golden parachute issues.
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Operational Nature and Characteristic

Tax review - evaluate Company’s overall level of compliance with existing laws and regulations;
caution them on procedures and practices that expose them to potential tax liabilities; quantify
tax exposures, risks and penalties; and advise them on proper course of action and alternative
tax-efficient policies and procedures. Tax due diligence review is particularly recommended for
companies that are contemplating expansion, mergers and consolidation, acquisitions, change
in ownership, or public listing.

Tax opinion and studies - conduct tax studies and provide advice to company on the tax
implications of specific transactions based on relevant laws, regulations, court decisions, rulings,
and other relevant issuances. Provide recommendations to address or mitigate tax issues
arising from said transactions.
https://www.grantthornton.com.ph/service/tax-advisory-and-compliance/tax-compliance/
Audit Procedure

1. Determine the tax regime of the company. If it is registered with the Board of
Investments (BOI) or with the Philippine Export Zone Authority (PEZA), check if it has
complied with the reportorial requirements which are prerequisites to enjoying the
special tax regime and incentives.

2. Inquire about observed discrepancies: (a) between the tax base in the audited financial
statements and the tax base in the tax returns; and (b) among the values declared in
the various tax returns (such as sales reported in the VAT returns versus sales reported
in the income tax returns, or values reported in the monthly versus the annual
withholding tax returns. Then, determine the nature of expenses deducted from gross
income and check if the payor, as the withholding agent, withheld the tax due thereon
on a timely basis and at the correct rate; failure to do so triggers the disallowance of the
expense with the resulting deficiency income tax exposure.

3. Ascertain timeliness not only of filing tax returns and payment of taxes, but also of tax
treaty relief applications (TTRAs) in the case of payments to non-residents resident in
tax treaty countries. There has been a wave of assessments issued to companies which
withheld taxes on dividend payments, interest payments, and royalty payments to non-
residents at preferential rates provided under the relevant tax treaties, without first
having filed a TTRA. The assessments are for deficiency withholding taxes, i.e., the
difference between such preferential rates and the withholding tax rates provided in the
Tax Code for payments to non-residents.

4. Ask about prior transactions of the company. With the recent Supreme Court decision in
one case, intercompany loans and shareholder advances are now subjected to the 0.5%
documentary stamp tax (DST) on the issue value of the loan, due not later than five
days following the end of the month when the “loan agreement” was executed. The sale
or transfer of Philippine company shares (if any) held by the target company is subject
to capital gains tax (CGT) on net gains realized. The target company selling or
transferring Philippine company shares could also be liable for donor’s tax if the fair
market value of the shares sold or transferred is greater than the cash and/or the fair
market value of the property received in exchange, as such excess could be deemed a
gift subject to donor’s tax.

5. Check for tax audits which are pending or which the target company considers as
“closed.” Most companies just pay deficiency tax assessments after receiving a Post-
Reporting Notice or after executing a Taxpayer Agreement Form. Neither document
guarantees that the audit is terminated for a given tax year. Only a Termination Letter
provides such comfort, since it states that the case is considered closed and terminated
and filed for future reference.
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2012/

Accounting Method Options of Due Diligence

Tax accounting is a structure of accounting methods focused on taxes rather than the
appearance of public financial statements. Tax accounting is governed by the Internal Revenue
Code, which dictates the specific rules that companies and individuals must follow when
preparing their tax returns.

https://www.investopedia.com/terms/t/tax-accounting.asp

Follow Up Work of Due Diligence

Documentation of tax compliance and potential issues typically includes verification and review
of the following:

Copies of all tax returns – including income tax, withholding, and sales tax – for the past three
to five years

Information relating to any past or pending tax audits of the company

Documentation related to NOL (net operating loss) or any unused credit carryforwards of
deductions or tax credits

Any important, out-of-the-ordinary correspondence with tax agencies

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