SOUTH AFRICA: TAX DUE DILIGENCE – AN ASSESSMENT OF EXPOSURE RISK AND OPPORTUNITY RISK
A tax due diligence is a complex, risk-based investigation into the tax affairs of a legal entity and is undertaken for interested parties, such as buyers, sellers, financiers and sponsors of public offerings.
The recent development of various accounting standards (International Financial Reporting Standards) and the introduction of these standards into our tax legislation requires assessment, in particular with regard to the creation of timing differences. These developments, coupled with annual amendments to the tax legislation, have necessitated the involvement of both tax law and accounting standards specialists in conducting a tax due diligence.
The tax due diligence process generally entails the review of tax returns (and supporting schedules), contracts/agreements regulating material transactions, share incentive scheme rules, correspondence with the South African Revenue Service (SARS), annual financial statements and other related documentary evidence.
A tax due diligence provides interested parties with an assessment of tax risk, and its financial impact, within an organisation. Tax risk is not limited to negative exposures, exposure risk (ER), but also includes an assessment of opportunities, opportunity risk (OR) not addressed by the organisation.
A potential bidder requires an assessment and quantification of tax risk, and a recommendation in relation to the risk identified. The latter is often an aspect of the tax due diligence investigation, and its report, that is sometimes over-looked. Buyers require input as to whether, in the opinion of the advisor, an issue requires a contractual indemnity or warranty, a price adjustment or whether it can be resolved post-deal.
A seller will undertake a due diligence (often where a multitude of bidders is expected) in order to highlight risk within an organisation for potential bidders and to address remediation procedures that have been undertaken or procedures which will be undertaken to limit the identified risk.
Whilst the purpose of the tax due diligence is often risk identification, in our experience, the due diligence is equally a process with the objective of identifying opportunities, such as accelerated allowances and tax incentives, which the organisation may not have considered.
From a tax perspective, the due diligence investigation typically covers the following areas:
- Domestic income tax and capital gains tax (including assessment of cross-border issues);
- Exchange control;
- Employees’ tax;
- Value-added tax;
- Dividend withholding tax;
- Securities transfer tax; and
- Customs and excise.
Tax legislation and accounting standards are independently regulated by their own set of rules, however, the interconnectivity between the accounting and tax rules is becoming more prevalent, a) in our tax legislative provisions and b) in assessing the tax dimension of accounting rules and concepts.
A proficient understanding of the some of the more recent accounting standards, such as IFRS 15 - Revenue from Contracts with Customers, is required in order to assess whether or not the tax treatment accords with the accounting treatment. Tax professionals are required to work more closely with their accounting counterparts in order to address inconsistencies between the accounting and tax treatment of rights and obligations.
Bowmans has a multi-disciplinary tax team providing tax due diligence services, consisting of both chartered accountants and admitted attorneys, with experience across the various areas of tax law.