Approach to Tax Due Diligence[1]
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Transcript of Approach to Tax Due Diligence[1]
INDIA
Approach to Tax Due Diligence
February 25, 2009
M&A TAX
2© 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.
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
8© 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.
Due Diligence – The Process
9© 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.
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
10© 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.
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
14© 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 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
15© 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.
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
20© 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…
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