INDIA

Approach to Tax Due Diligence

February 25, 2009

M&A TAX

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Contents of the presentation

Tax Due Diligence – An overview

The Process

Deliverables – Report-drafting & Conclusions

Key Considerations

Identifying business opportunities

Annexures

3© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

What is “Due Diligence”

American Management Association

“Process for seeking sufficient information about a business entity to reach an informed judgment as to its value for a specific purpose”

• Potential investors should have an understanding of the risks associated with the business he proposes to acquire

• Knowledge of the Target and a detailed understanding of its business risks critical in price negotiations

• Tax Due Diligence helps in identifying potential tax exposures pertaining to the Target

4© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Tax Due Diligence – An overview

5© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Which HAT should we DON???

Tax Advisor Consultant Auditor

Open Tax Issues

Integration Issues

Valuation Issues

Our scope is restricted to highlighting the potential tax issues and report non-compliance by the Target

We are not to advise the client on Tax Strategies to mitigate any risk during the due diligence process

6© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Want of a Due Diligence

Buy-side

Cases where we have been appointed by the INVESTOR to perform a diligence on the TARGET

Strategic investment by investors for acquiring controlling stake in the Target

Financial investment by investors without acquiring control of the Target

Investments by Private Equity Funds / Venture Capital funds in the Target

Acquisition of an undertaking or a part of an undertaking of the Target

Sell-side

Cases where we have been appointed by the TARGET to perform a diligence on itself

Sale or hive-off of an undertaking or a part of an undertaking by the Target

Divestment or sale of stake by the Target to potential bidders

Vendor Due Diligence to identify potential buyers

7© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Acquisitions

Critical to highlight open tax issues & the underlying tax risks

Significant tax-outflow / potential tax liability in the hands of the Target may be a factor in consummation of the transaction

Comment on the provision towards tax in books and the nature of contingent liability, if any

Section 79 issue in case of closely-held companies

Sale of undertaking / asset sale

Significant contingent liability on account of taxes could be an issue – Section 281 of the Act

Continuity of any tax-benefits in the hands of the buyer to be ascertained

Potential tax exposure to the buyer as a successor of business to be highlighted

Key Drivers from a Direct Tax perspective

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Due Diligence – The Process

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Under the scope

As a first step, obtain the Letter of Engagement and understand the following;

Exact scope of work and expectations of the TS Team / Client

Limited DD vis-à-vis Detailed DD?

Our client – Buyer or Seller…

Critical to understand the “Historical Period” covered in the scope of work

Fact finding exercise should be restricted to the Historical Period

Open tax assessments and tax liability pertaining to period prior to the “Historical Period” should be highlighted

Potential Tax exposure on consummation of transaction may be highlighted though outside the “Historical Period”

Communicate the projected time-cost and time-overruns if any at the outset

Find out the deadlines to issue report and obtain a format of the DD report

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Familiarizing the Transaction

Prior to meeting the Target

Obtain an understanding of the Target, its business, Promoters, etc.

Understand the business sector and common tax issues relating to that sector

Peruse the financial statements / corporate presentations if the Target is publicly traded

Hold discussions with TS Team and obtain an understanding of the Transaction

Background and the proposed transaction structure;

Promoter tax liability or implications;

Obtain the ‘Term Sheet’ or ‘Transaction Memorandum’ if any to understand the mechanics

Obtain other related documents available including financial statements, Target PPTs, etc.

11© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Knowing the Target

Get a detailed understanding of the business of the Target and the proposed transaction structure

Critical to understand the rationale of the proposed transaction viz.

Fund raising exercise through strategic / financial investment

Divestment to raise funds for other business

Sale of non-core businesses

Focus on key tax issues while holding discussions with CFO, key management personnel, etc.

A detailed IRL to be provided to the Target and TS contact on conclusion of meeting

Ask for all information needed to quantify exposures

Agree time-lines with the Target for provision of information

12© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Information Requirement List – An overview

Audited Financial Statements for the Historical Period

Tax Audit reports for the Historical Period

Returns of Income for the Historical Period

Copy of orders, notices, documents, etc. issued by the Revenue

Copy of TDS returns

Assessment Status with a description of the amounts involved, demand raised, tax paid, tax authority involved, etc.

Details of contingent liability reported on account of tax demand raised and the nature thereof

Critical agreements entered into by the Target, as deemed relevant for the transaction

Ledger extracts, if relevant, of the following;

Related party transactions;

Provision for tax;

Expense heads with significant sums

13© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Deliverables – Report-drafting & conclusions

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What to report

Comment on direct tax filings for the scope period, including:

Timeliness of filings

Aggressive positions adopted - should be highlighted with judicial precedents

Review documents relating to open assessments / appellate proceedings and comment on potential tax exposures

Exposure to be quantified on an estimate basis

Comment on possibility of tax exposures in foreign tax jurisdictions

Comment on TDS filings, if within scope

Comment on adequacy of provision for tax

Comment on tax benefits and their availability in the future

Output in the form of:

Summary of issues

DDR report

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Report format – Points for consideration

Executive Summary – Headlines

Meant to highlight key issues for Management / CEO / Promoters, etc.

Should highlight key & significant tax issues and quantify the potential exposure

Should not be verbose and should not contain references to sections/citations

Executive Summary – Key Findings

Meant to highlight issues / finding to CFO / Finance Team

Should report all the key findings of the review and quantify the potential exposure

Should not be verbose and detailed in nature

Supporting Analysis to Key Findings

Detailed analysis to support the key findings

Should include details of documents reviewed, discussions with Target officials, judicial precedents, quantification of exposure, etc.

Scope & Limitations

Should highlight the documents / details that were provided for our review

16© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Concluding an issue

Conclusions should be fact-based and based on the inputs given by the Target

Supporting analysis to the key findings should clearly highlight the following points

Case laws including citation, year, and jurisdiction of the concerned tax authority

Circulars, instructions, etc. issued by the Revenue

Documents provided by the Target should be clearly communicated

Management information or information provided by the Target’s personnel

External sources of information – Websites, etc.

Research resouces for drawing conclusions include;

Provisions of the Act;

Case laws pronounced by judicial authorities;

Commentaries on the provisions of the income-tax act

17© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Tax findings significant in decision-making

Deal Breakers

Where the potential issue could derail the consummation of the transaction – Tax issues may be a deal breaker

E.g. Non-compliance with key regulations, etc.

Valuation Issues

Where the potential issue would be relevant in determining the valuation of the business – Significant tax issues may in some cases impact the valuation of the business

E.g. Non-availability of tax benefits under section 10A/10AA, etc. – Could potentially increase tax outflow by 33%

18© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Warranties and Indemnity

Parties to transactions typically seek reps and warranties to cover issues over which they are concerned

Where the consummation of the transaction would warrant seeking an indemnity for potential future tax liability

Other tax findings

Tax risks knowingly taken over on the basis where other commercial parameters for consummation of transaction are in favour

Tax findings significant in decision-making

19© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Key Considerations

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Key Considerations…

Identify key issues at an early stage and discuss the same with the TS contact / Client

Seek clarifications from the Target prior to commenting on potential tax exposures in the report

Refrain from communicating potential tax exposures with the Target officials prior to conclusion of the DD

Quantify estimated amount and the likelihood of exposures resulting in future tax cash outflow

Report should be in plain English – should avoid technical jargon as far as possible

Address the parties as ‘acquirer’ and ‘target company’

Liaise with the identified contact of the target

21© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Key Considerations…

Do not discuss details of assignment with identified contact or any employees of the Target

End each day with a list of pending information

Escalate if information not flowing through

Seek information needed to quantify exposures

Avoid commenting on deferred taxes unless specifically asked for

Discussion with target company only along with supervisor

Maintain confidentiality

When in doubt, seek help either from supervisor or TS

22© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Identifying Business Opportunities

23© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Identifying Business opportunities

Buy-side opportunities

Understand the proposed investment structure of the investor – Potential tax and regulatory issues to be identified

Alternative structures could be evaluated to mitigate any pain points

E.g. Jurisdiction analysis and capital structuring where the buyer is a non-resident

Tax issues identified during the DD could be significant – possible to suggest ways to mitigate tax exposure

E.g. Section 79 issue where losses cannot be carried forward

Sell-side opportunities

Evaluate possible mechanics for hive-off of business or company

E.g. Sale of business through demerger, slump sale or itemized sale

Promoter taxability may be an issue where the promoter exits the business or dilutes stake

24© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Annexures

25© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Annexure 1 – “Reps & Warranties” and “Indemnity”

“Reps & Warranties”

Reps & Warranties means “statements by which one party gives certain assurances to the other, and on which the other party may rely”

E.g. Rep is given with respect to carved out financial statements that they are correct (mostly unaudited numbers)

Where the Rep / Warranty is breached, parties have remedies under the agreement to seek relief from the other party

Indemnity

Indemnity means “to compensate another party to a contract for any loss that such other party may suffer during the performance of the contract”

Indemnity is a protection mechanism, when you have a quantifiable estimate of any contingency that you will like to safeguard yourself against

E.g. Buyer may seek indemnity against contingent tax liability that may devolve, tax liability pertaining to the seller required to be borne by the buyer, etc.

26© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Annexure 2 – Illustrative Check List of Issues (1/2)

Implications of deemed dividend

Restructuring (if any) and its implications on carry forward of tax losses and depreciation

Tax benefits (if any) claimed by the company and conditions as to its eligibility

Implications of change in shareholding in case of closely held companies

Applicability of Section 14A of the Act

Regulatory approvals, if any

Transfer pricing implications if any

Applicability of section 40(a)(i) / 40(a)(iii)

Examination / verification of the reconciliation of TDS claim with taxable income

Eligibility to claim foreign tax credit in India tax return

27© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Illustrative Check List of Issues (2/2)

Deductibility of interest u/s 36(1) (iii) of the Act

Deductibility of bad debts / provision for bad debts

Examination of whether the deduction claimed in respect of contractual/statutory liability is allowable in the year under consideration

Examination of whether provisions made on an estimated basis are allowable as expenditure in computation of business income

Examination of details of Miscellaneous/Sundry expenses for ascertaining whether the said heads contain certain expenditures not allowable under the Act

Examination of whether the payments made for expenses are disallowable under section 40A(3)

Examination of tax treatment of “Provision for doubtful debts” while computing “Book Profits” under MAT

28© 2009 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Thank You