The Tax Issues Buyers Find in Due Diligence, and How Sellers Can Fix Them First

Every serious buyer will look closely at your tax affairs before it pays you. What the review finds can change the price, the payment terms and how long you stay on the hook after completion. The good news is that most of the common findings can be spotted, and often corrected, before a buyer sees them.

What happens when an issue is found

When tax due diligence uncovers a problem, the buyer will usually ask for one or more of the following:

• A price reduction reflecting the expected cost.
• A specific indemnity, which is a promise to pay for that liability pound for pound if it arises.
• A retention or escrow, where part of the price is held back until the risk passes.
• A warranty and indemnity insurance exclusion. Insurers normally exclude known issues, so the risk stays with you.

Tax warranty and indemnity claims commonly run for four to seven years after completion, so a problem left open can follow you long after the sale.

Employment taxes

This is often where most findings arise.

• Off-payroll working (IR35). Contractors and consultants, including former staff, may never have been assessed properly. If they should have been on the payroll, PAYE and National Insurance can be due.
• Benefits and expenses. Unreported benefits, informal arrangements and expenses paid incorrectly.
• Share schemes and EMI. Late or missing notifications to HMRC, missing annual returns, unclear option agreements and shares issued to employees with no thought given to their value.

What you can do: review contractor arrangements and record how you reached each status decision, check how benefits are reported, and assemble the full paperwork for every share issue and option grant. Some share scheme faults can be remedied before a sale. Others will need to be disclosed and priced.

VAT

VAT mistakes can pile up over several years unnoticed. Typical findings include:

• The wrong rate or treatment on certain supplies.
• Reverse charge errors on services bought from overseas.
• Partial exemption calculations that have not been updated.
• Property transactions, including options to tax that were not properly made or notified.

What you can do: have the VAT treatment of your main income streams and any property reviewed. If you find errors, correct them with HMRC before the sale.

Corporation tax computations

Buyers will examine your recent returns and computations. Common points are:

• Expenses claimed that are not deductible.
• Capital allowances claimed on the wrong assets or at the wrong rate.
• Overdrawn directors' loan accounts and the tax that goes with them.
• Losses or reliefs carried forward without clear support.

What you can do: have recent computations reviewed, make sure every figure can be supported, and clear directors' loan accounts in good time.

R&D claims

HMRC has stepped up its checks on R&D claims, and buyers know it. They will ask whether the projects really qualified, how the costs were calculated and who prepared the claims.

What you can do: collect the technical narrative and cost workings behind every claim. If a claim looks weak, consider amending it before the sale and not leaving it for the buyer to uncover.

Past reorganisations without clearance

Earlier share exchanges, demergers, new holding companies and transfers within a group can have effects that last for years. Where no HMRC clearance was obtained, the buyer cannot easily confirm the tax treatment. Leaving a group can also trigger charges on assets that were moved within it.

What you can do: gather the paperwork for every past reorganisation and have the tax treatment confirmed. If a restructure is needed ahead of the sale, plan it early, with clearance where appropriate.

Transfer pricing in groups

Where a group trades with related companies, especially overseas ones, prices should match what independent parties would agree. Smaller groups are often exempt, though not always, and buyers will check.

What you can do: document intra-group charges, management fees and loans, and confirm whether an exemption applies.

Weak records

Missing records seldom create a tax liability by themselves, but they make everything harder. If you cannot show how a figure was reached, the buyer will assume the worst and demand wider protection. HMRC can generally go back several years, and further for careless or deliberate errors, so gaps in your records widen the risk.

What you can do: organise tax returns, computations, HMRC correspondence, payroll and VAT records and share scheme documents before the data room opens.

Putting things right before the sale

When you find an error, a voluntary disclosure to HMRC is often better than leaving it for the buyer. It can reduce penalties and converts an open-ended risk into a known cost. Some sellers also commission their own tax due diligence, which brings problems to light early and gives every bidder the same information.

Fair disclosure in the disclosure letter can protect you against warranty claims. It does not normally limit claims under the tax covenant, so known issues still need to be dealt with directly.

Pre-sale checklist

• Review contractor and consultant arrangements for off-payroll working.
• Check how benefits and expenses are reported.
• Collect all share scheme and EMI documents, notifications and returns.
• Have the VAT treatment of main income streams and property checked.
• Review recent corporation tax computations and directors' loan accounts.
• Gather the support for every R&D claim.
• Assemble documents and clearances for past reorganisations.
• Document intra-group pricing.
• Correct known errors with HMRC.
• Organise your records before the data room opens.

Let our team review your position first

A review before you go to market costs far less than a price reduction in the final weeks of a deal. Our specialists can carry out a seller-side review and advise on what to fix, disclose or leave. The advice is prepared by our specialist team and reviewed by a Chartered Tax Adviser. Book a call with our team to start while there is still time to act.

This article is general information, not advice. Tax rules change and their effect depends on your circumstances. Please speak to us before acting.

For a closer look at selling or buying a business, see our specialist practice, Transaction Tax Partners.