Tax due diligence: what is it and when is it necessary?

Acquiring a business is a major investment decision. While commercial and financial diligence often take centre stage, tax due diligence is an important tool to help a purchaser protect value and identify opportunities.

Whether the transaction involves the purchase of shares in a limited company or a trade and asset acquisition, understanding the tax position of the target can significantly influence the deal structure, price and post-completion outcomes.

Learn the key benefits of tax due diligence, the types of issues commonly identified, and how the findings feed into the overall transaction process below. 

Share purchase vs asset purchase – why tax matters

The scope and risk profile of tax due diligence differs depending on how the acquisition is structured:

• Share purchase: The buyer acquires the company together with its full trading history, including historical tax liabilities.
• Trade and asset purchase: Selected assets and liabilities are acquired, which can reduce historical exposure but still creates specific risks.

Key benefits of tax due diligence

Some common benefits include:

• Identifies hidden liabilities that may not be visible in financial statements.
• Supports price negotiations where risks are identified.
• Informs deal structure and pre-completion planning.
• Enhances protection through warranties, indemnities and tax covenants in the SPA.
• Highlights opportunities such as unclaimed reliefs or improved structuring.

What are common risk areas in tax due diligence? 

A tax due diligence exercise will focus on areas and risks depending on the size, nature and market of the entity involved. However, some common risk areas include:

• Corporation tax: incorrect positions, under-provisioning or timing issues.
• Employment taxes: contractor status risks, payroll errors and share schemes can lead to significant tax exposures, particularly where individuals have been engaged as consultants but ought to be treated as employees. Significant exposures can arise in this area.
• VAT: incorrect treatment of supplies and recovery issues can lead to historical VAT exposures, which require disclosure, and cross-border transactions can give rise to risk in overseas jurisdictions.
• International aspects: transfer pricing, permanent establishment risks and withholding taxes.
• Historical transactions: poorly implemented reorganisations or uncertain tax positions can create tax risk, so it is important to review and understand.
• Compliance: HMRC enquiries and irregular filing history can lead to tax risk.

Levels of tax due diligence

Typically a purchaser will wish to undertake a level of tax due diligence commensurate with the size and nature of the deal. Commonly there are two main levels of work, including:

1. Red flag review: this is a focused, high-level identification of key risks, to identify certain areas for consideration in further detail. This can reduce costs, whilst ensuring the main points are covered.

2. Full scope review: this is a detailed and comprehensive analysis across all tax areas, often taking a considerable amount of time and cost. This is more relevant when a purchaser wants to know all about the tax history and attributes of the target.

How does tax due diligence impact a deal?

Tax due diligence findings impact various aspects of a transaction:

• Sale and Purchase Agreement (SPA) protections: findings often drive the warranties, indemnities and tax covenants that apply to a transaction, ensuring risk is allocated and addressed appropriately. Specific findings from due diligence are commonly handled in the SPA.

• Price adjustments: liabilities identified in the due diligence process can lead to negotiated price reductions, deferred consideration or amounts held in escrow (held to one side until those liabilities are resolved).

• Disclosures: certain historical tax liabilities may lead to voluntary disclosures to HMRC post-deal, or a pre-completion clean-up.

• Post-acquisition planning: identifying opportunities such as relief claims can lead to tax savings (for the purchaser) post-transaction. The due diligence process can also set out a roadmap for aspects to be dealt with once the purchase completes.

Conclusion

Tax due diligence is a fundamental part of any business acquisition. It provides clarity over historical exposures, supports informed decision-making and helps ensure the deal is structured in a way that protects value.
For buyers, it is not simply a compliance exercise – it is a commercial tool that mitigates risk, strengthens negotiating position and unlocks opportunities for long-term value. Shorts can undertake tax due diligence covering all aspects of taxation of the target business, in a structured and cost-effective manner.