What is the purpose of sell-side tax diligence?

Frequently, companies will forego a sell-side tax diligence process, reasoning that there’s no reason to pay for diligence of their own when a buyer is just going to discover any issues during their diligence process and the seller can respond to those issues if and when they arise. 

While this is a valid approach and works 100% of the time when material tax issues don’t exist, the primary purpose of sell-side tax diligence is not to raise tax issues, it’s to flip the resolution of tax issues from a tax analysis to a business decision. 

What do we mean by that?  Well, in any sale process, there’s a balance of power that shifts throughout the course of the process. When in a multi-party process, buyers tend to evaluate issues by risk adjusting exposure.  Once exclusivity occurs, however, the buyer views their price as what they’re willing to pay for the company as they know it and the seller should take the risk for any other issues.  

To illustrate the issue, consider a Company that potentially failed to collect and remit sales taxes in 20 different jurisdictions where they’ve established economic nexus.  The total potential exposure is about $1,000,000, but that exposure is spread pretty equally over the 20 identified jurisdictions.  If one assumes that the odds of the exposure being realized in any jurisdiction is approximately 10%, the true cost of the exposure is $100,000 and a rational buyer with full knowledge in a competitive process would price it accordingly. 

But if the issue is raised by the buyer when it has conducted diligence procedures, the buyer is not incentivized to act rationally and may ask for indemnification with a $1,000,000 escrow for a 4 to 5 year period, full payment of the $1,000,000 through voluntary disclosure agreements, or just a straight purchase price adjustment. While a seller is never obligated to agree to those terms, its negotiating position is weakened by exclusivity.  

At Acta Consulting, we’re focused on optimizing your negotiating position in any transaction. That’s why we offer our clients high-level sell-side tax diligence procedures designed to identify significant tax issues without the cost and logistical challenge of full tax procedures. These high-level procedures may not identify every potential tax issue, but do give you the best chance at maximizing your sale proceeds.