Tax Due Diligence: Tax risks in corporate acquisitions

Tax due diligence is not a nice add-on to financial due diligence; it is often the area in which the most expensive legacy issues are hidden. Anyone who omits it in the German Mittelstand or initiates it too late risks assuming tax liabilities that only become apparent years after closing.

Tax due diligence: why the topic is often underestimated

Many M&A transactions in the German Mittelstand focus heavily on revenue quality, EBITDA, working capital and cash flow. Tax legacy issues, by contrast, often go unnoticed—even though, in a share deal, their economic burden can ultimately fall on the buyer.

This is the real blind spot: tax audits are often carried out with a delay, tax periods remain open for a long time, and tax risks are not usually examined in the same depth as financial risks in a conventional financial due diligence (FDD). This is precisely why tax due diligence (TDD) is not a formality, but an independent risk review with direct relevance to the purchase price, warranties and indemnities.

What tax due diligence achieves

Tax due diligence systematically examines the tax position of a target company and identifies risks, opportunities and structural issues before the acquisition. The focus is particularly on tax periods that can still be amended, open or completed tax audits, pending proceedings, the quality of tax compliance and specific risk areas such as VAT, payroll tax or transfer pricing.

TDD does not merely answer the question of whether the company has somehow filed tax returns to date. It reveals where hidden tax liabilities lie, which positions are vulnerable to challenge and which points should be properly secured in the purchase agreement.

It is important to know: financial due diligence explains how profitable a company is. Tax due diligence shows which tax legacy issues you are acquiring.

Three typical tax risk areas

1. Tax audit risks: prior years are not closed

Long periods without a tax audit are not unusual in the German Mittelstand. This may initially sound unproblematic, but it often means that several years remain open and that a later tax audit could trigger corresponding additional payments, interest and disputes.

Typical risk areas include unclear circumstances involving shareholder-managing directors, incorrect payroll tax treatment, insufficiently documented business expenses, trade tax additions or poorly demarcated provisions. What may seem manageable individually can quickly become a material purchase price risk over several years.

Without a thorough TDD, an unremarkable prior year can quickly turn into an expensive surprise after closing.

2. Intercompany transactions: a transfer price is not automatically defensible

As soon as several companies are involved—whether domestically or internationally—intercompany services become tax-sensitive. Intra-group supplies, management fees, loans or licence fees must comply with the arm’s length principle: they must be structured as independent third parties would agree.

In practice, what is often missing is precisely what is decisive for a later defence: robust transfer pricing documentation and a consistent derivation of the prices applied. If the tax authorities make adjustments here, there is a risk of profit adjustments, additional tax payments and further liabilities—particularly unpleasant for the buyer, because the cause often predates their involvement.

In practice, we almost always encounter the same three weaknesses in TDDs of German Mittelstand companies: historically evolved intercompany allocations without a clear contractual basis, undocumented shareholder or sister-company relationships, and pricing logic that has developed operationally but has not been substantiated in a tax-robust manner.

3. Tax loss carry-forwards and structural issues: opportunities that can evaporate

Not every TDD issue is a pure risk. Tax assets such as tax loss carry-forwards or certain structural advantages also need to be scrutinised, because they may cease to apply in whole or in part as a result of a change of ownership.

Anyone who takes a tax advantage into account in the purchase price that later cannot be used is paying for an advantage that cannot be realised. A TDD therefore examines not only liabilities arising from the past, but also whether purported tax assets can be realised economically at all.

Why financial due diligence is not enough

Many decision-makers assume that tax matters are already covered in an FDD. This is only true to a limited extent. The FDD primarily looks at earnings quality, cash conversion, balance sheet ratios and the plausibility of financial figures—tax-related detail questions are generally only addressed to the extent that they are directly visible in the financial picture.

That is where the gap lies. Open tax audit years, transfer pricing documentation, payroll tax and VAT compliance, or the usability of tax loss carry-forwards require a different review approach and genuine tax expertise. Anyone who only addresses these issues at the margins regularly overlooks precisely the tax liability risks that later become relevant to the purchase price or give rise to liability.

What this specifically means for buyers and sellers

For buyers, TDD provides the basis for properly quantifying risks and translating them into the transaction documentation. Once risks have been reliably identified, they can be addressed through purchase price adjustments, escrow arrangements, specific tax indemnities or warranties.

For sellers, tax due diligence is also strategically sensible. It helps identify known weaknesses before the process begins, prepare data rooms properly and proactively manage discussions during the bidding process—rather than being pushed into a defensive position by the buyer’s advisers.

Especially in the German Mittelstand, this is a real lever. Many transactions do not fail because of the fundamental logic of the deal, but because of uncertainty, loss of momentum and mistrust during the later review phase. A well-prepared tax perspective reduces precisely this friction.

What ACCONSIS specifically does in tax due diligence

In TDD, we use a structured, risk-oriented review approach. This means that we analyse the tax status of the relevant years, prioritise the issues that are genuinely relevant to the transaction, translate findings into economic consequences—and integrate the results with the FDD, purchase agreement and negotiation strategy.

This is particularly evident where figures and taxes interact: in shareholder structures, intra-group service relationships, atypical financing arrangements, special VAT situations or unresolved tax audit issues.

Typical services in a TDD for the German Mittelstand:

• Analysis of open tax years and ongoing or completed tax audits
• Review of transfer pricing documentation and compliance with the arm’s length principle
• Tax compliance check (corporate income tax, trade tax, VAT and payroll tax)
• Usability of tax loss carry-forwards and tax-related structural advantages after the acquisition
• Translation of tax risks into contractual language: indemnities, escrow and warranty schedules
• Vendor tax DD: preparation of the tax position before the process begins from the seller’s perspective

For decision-makers, what ultimately matters is not merely that risks are “identified”. What is decisive is that they are prioritised, assessed in economic terms and prepared in a form suitable for negotiation—before they become an issue of liability in the purchase agreement.

The real question is not whether a tax risk exists, but whether it is identified early enough to be addressed in the purchase price, structure and agreement.

Discuss tax due diligence before the transaction!

Are you currently preparing a deal, on either the buyer’s or seller’s side? Or are you realising during the review phase that more is at stake from a tax perspective than you thought?

An early sparring call is usually more sensible than a later dispute over legacy issues. Arrange a free introductory meeting.

Arrange a free introductory appointment.

Your ACCONSIS contact

Bastian Regenhardt
Master of Science
Certified public accountant
Authorised signatory of ACCONSIS

Service phone
+49 89 547143
Email
b.regenhardt@acconsis.de

Frequently asked questions about tax due diligence

What does tax due diligence typically examine in the German Mittelstand?

It typically examines open tax years, the status of tax audits, tax compliance, transfer pricing, tax loss carry-forwards, specific structural issues and material risks in tax types such as corporate income tax, trade tax, VAT and payroll tax.

From what transaction size does TDD pay off?

It is not only worthwhile for major transactions. Even in the lower to mid single-digit million range, a single unresolved tax issue can be economically more significant than the review budget saved.

Is an FDD with some tax awareness not sufficient?

In straightforward cases, a rough tax overview may be sufficient. However, as soon as several companies, intercompany relationships, open audit years or specific tax issues are involved, this is regularly not enough.

Why are transfer prices so often a problem?

Because intra-group prices may be set quickly for operational purposes, but must be documented and justified on an arm’s length basis for tax purposes. This documentation is often incomplete or inconsistent in established German Mittelstand groups.

When is a vendor tax DD sensible?

Whenever the seller wants to prepare the tax position proactively—to manage discussions during the bidding process, prepare data rooms fully and prevent the buyer from using tax uncertainties as a lever on the price.

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