When a buyer analyzes a company with a view to acquiring it, tax due diligence is one of the processes with the greatest impact on the final price and the protections they'll require. A tax contingency that isn't detected in time can result in a downward price adjustment, a holdback of part of the price through escrow, or even the deal falling through.
In this guide, we explain exactly what tax due diligence is, which tax areas it reviews, the most common contingencies found in deals in the Spanish mid-market, and how to prepare if you're going to sell your business so you can get through it without surprises.
What is tax due diligence?
Tax due diligence —also called a tax review— is the in-depth analysis of a company's tax position carried out during a sale process. Its goal is to identify tax contingencies (risks arising from compliance or non-compliance with tax obligations) that could affect the value of the deal.
It's one of the 7 types of due diligence carried out in an M&A deal, alongside financial, legal, commercial, labor, technology, and ESG due diligence. Unlike financial due diligence (which focuses on the accounts and EBITDA) and legal due diligence (which reviews contracts and litigation), tax due diligence deals specifically with taxes: what the company has declared, what it has paid, and what the Spanish Tax Agency (Agencia Tributaria) could claim from it in the future.
Why tax due diligence is critical
Tax contingencies have a peculiar feature: they're retroactive. The Spanish Tax Agency can review the last 4 tax years (the general statute of limitations in Spain) and, in certain cases —fraud, sham transactions, poorly documented related-party transactions— up to 10 years. This means the buyer takes on not only the company's current situation but also the risk that tax issues from previous years will come to light.
That retroactive risk explains why tax findings tend to carry so much weight in the negotiation:
- They translate into direct price adjustments when the risk can be quantified.
- They're covered by specific clauses in the SPA (tax representations and warranties).
- They may require a tax escrow: part of the price held back for years to cover potential claims from the tax authorities.
What does tax due diligence review?
The scope varies depending on the size of the company, but a full tax due diligence typically covers:
1. Corporate income tax (Impuesto sobre Sociedades, IS). Corporate income tax compliance for the last 4 tax years, off-book adjustments, deductions applied (R&D&I, training, reinvestment deduction), tax loss carryforwards pending offset and their applicability.
2. VAT. The regime applied, output and input VAT, VAT deductions on specific transactions (real estate, vehicles, business entertainment), adjustments, and pro rata if the company carries out exempt transactions.
3. Personal income tax (IRPF) / Withholdings. Withholdings on employees, professionals, rent, and dividends. Withholding errors are very common findings in SMEs.
4. Related-party transactions. If the company has transactions with shareholders, directors, or group companies, the documentation must strictly comply with transfer pricing rules. It's one of the favorite focal points of tax inspections.
5. Local taxes. Property tax (IBI), business activity tax (IAE), construction tax (ICIO), municipal capital gains tax on real estate transfers, and applicable local fees.
6. Customs and excise taxes. Only applies to companies with import/export activity or in specific industries (alcohol, hydrocarbons, electricity).
7. Open litigation and proceedings. Ongoing inspections, pending appeals before the Central Economic-Administrative Court (TEAC) or the courts, and information requests.
8. Corporate structure. Analysis of the tax efficiency of the current structure, possible restructurings before the deal, and taxation of the transfer itself (capital gains for the sellers).
When is tax due diligence carried out in the M&A process?
Tax due diligence is carried out in the same stage as the other due diligence reviews: after signing the LOI and before the SPA. It's the point of maximum scrutiny in the process, and where findings can change the price agreed in the non-binding offer.
How to prepare your business for tax due diligence
If you're thinking about selling your business, there are three levels of preparation depending on how much time you have:
12–24 months in advance. This is the ideal scenario. It allows you to carry out a preventive tax review (what's known as vendor tax due diligence) to identify contingencies and resolve them before starting the process. It also gives you room to restructure the company if it makes sense from a tax standpoint, regularize questionable situations, and properly document related-party transactions.
6–12 months in advance. There's still time to prepare the documentation properly, hire tax advisors specialized in M&A, and address the most serious contingencies. They can't always be resolved, but at least they can be quantified and presented to the buyer with a plan.
No time (due diligence already underway). If due diligence is already underway, the only thing you can do is offer full transparency. Hiding tax contingencies is the worst strategy: if the buyer detects them after closing, the losses are claimed through the SPA warranties. It's better to raise them during the negotiation.
In any of the three cases, having a tax advisor specialized in M&A —not just a tax advisor for day-to-day compliance— makes the difference. The taxation of a corporate transaction is very different from day-to-day taxation.
The role of the M&A advisor in tax due diligence
Although tax due diligence is performed by specialized tax advisors (Big Four firms, tax boutiques, or law firms), the seller's M&A advisor plays a key role in how the findings are handled: translating them into price adjustments, warranty clauses, or the payment structure.
🎙️ To learn about the role of the intermediary in M&A, listen to episode 2x01 of Rainmaker, our podcast, with Antonio Valverde:
