What buyers' tax due diligence finds, and how sellers can fix it first

When you sell your company, the buyer takes on its tax history. Buyers protect themselves through tax due diligence, and anything they find becomes a negotiating point. Most issues are not unusual. What matters is whether they're found and dealt with by you before the sale, or by the buyer during it.

Why findings matter to the price

When due diligence finds a tax issue, the buyer will usually ask for one or more of these:

• A price chip: a reduction in the price to reflect the expected cost.
• A specific indemnity: a promise to pay for that liability, pound for pound, if it arises.
• A retention or escrow: part of the price held back until the risk falls away.
• A W&I exclusion: W&I insurers usually exclude known issues found in due diligence, so the risk stays with you.

Tax warranty and indemnity claims commonly run for 4 to 7 years after completion. An issue left open can affect you long after the sale.

Employment taxes

This is often the area with the most findings.

• Off-payroll working (IR35). Contractors and consultants, including former staff, may not have been assessed properly. If they should have been on payroll, PAYE and National Insurance may be due.
• Benefits and expenses. Unreported benefits, informal arrangements and incorrect expense payments.
• Share schemes and EMI. Missing or late notifications to HMRC, missing annual returns, unclear option agreements, and shares issued to employees without considering their value.

What sellers can do: review contractor arrangements and document status decisions, check benefits reporting, and gather the full paperwork for every share issue and option grant. Some share scheme issues can be fixed before a sale. Others need to be disclosed and priced.

VAT

VAT errors can build up over several years without anyone noticing. Common findings include:

• the wrong VAT rate or treatment on certain supplies
• reverse charge errors on services bought from abroad
• partial exemption calculations that haven't been updated
• property transactions, including options to tax that weren't properly made or notified

What sellers can do: have the VAT treatment of the main income streams and any property reviewed. Where errors are found, correct them with HMRC before the sale.

Corporation tax computations

Buyers will review recent returns and computations. Typical points are:

• expenses claimed that aren't deductible
• capital allowances claimed on the wrong assets or at the wrong rate
• overdrawn directors' loan accounts and the related tax
• losses or reliefs carried forward without clear support

What sellers can do: have the recent computations reviewed, make sure the figures can be supported, and clear directors' loan accounts in good time.

R&D claims

HMRC has increased its compliance activity on R&D claims, and buyers know it. They will look at whether the projects really qualified, how costs were calculated, and who prepared the claims.

What sellers can do: gather the technical narratives and cost workings for each claim. If a claim looks weak, consider whether it should be amended before a sale rather than left for the buyer to find.

Past reorganisations without clearance

Earlier share exchanges, demergers, new holding companies and intra-group transfers can have consequences that last for years. Where HMRC clearance wasn't obtained, the buyer can't easily confirm the tax treatment. Leaving a group can also trigger charges on assets transferred within it.

What sellers can do: collect the documents for every past reorganisation, and have the tax treatment confirmed. If a restructuring is needed before the sale, plan it early, with clearance where appropriate.

Transfer pricing in groups

Where a group trades with related companies, particularly overseas, prices should reflect what unconnected parties would agree. Smaller groups are often exempt, but not always, and buyers will check.

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

Poor records

Missing records rarely create a tax liability on their own, but they make everything harder. If you can't show how a figure was reached, the buyer will assume the worst and ask for wider protection. HMRC can usually go back a number of years, and longer for careless or deliberate errors, so gaps in records widen the risk.

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

Fixing issues before the sale

Where an error is found, a voluntary disclosure to HMRC is often better than leaving it for the buyer. It can reduce penalties, and it turns an open-ended risk into a known cost. Some sellers also commission vendor tax due diligence, so issues are found early and bidders start from the same information.

Fair disclosure in the disclosure letter can protect you against warranty claims. It doesn't usually 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 benefits and expenses reporting.
• Gather 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 support for every R&D claim.
• Collect documents and clearances for past reorganisations.
• Document intra-group pricing.
• Correct known errors with HMRC.
• Organise records before the data room opens.

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