Why is tax due diligence important?
29 Jul 2026 • Business Tax • Insight • Transaction Tax
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Tax due diligence is a fundamental requirement of any successful acquisition or investment process. While it is often perceived as a review of historic compliance, its real value lies in identifying issues that could crystallise into liabilities after completion, influence transaction terms or negatively affect the long‑term value of the investment.
In the current UK tax environment, with increasingly complex legislation and heightened HMRC scrutiny, tax risks can be wide‑ranging and, in many cases, are not immediately visible from statutory filings alone. Performing tax due diligence provides clarity over these risks, enabling informed decision‑making and effective protection within the transaction documentation.
Tax due diligence is more than a compliance exercise
The primary purpose of tax due diligence is to assess whether the target business has complied with its tax obligations and whether any historic or ongoing issues could result in a tax liability crystallising for the buyer post‑completion. However, its value goes beyond reviewing tax returns and filings. The tax due diligence process can:
Identify historic liabilities that may justify price adjustments, escrows or specific indemnities
Highlight weaknesses in the target’s processes that can be addressed after the transaction has taken place
Evaluate the availability of tax attributes (such as losses) post completion
While the tax covenant included in the share purchase agreement (SPA) may provide the buyer with the mechanism for recovering tax liabilities from the sellers, this process can often be time consuming and costly, particularly if there is disagreement over the validity or quantum of the claim.
Identifying potential tax risks before the transaction ensures they can be dealt with appropriately prior to completion. This may mean negotiating a reduction in the purchase price, obtaining specific indemnities for identified risks, or requiring the sellers to remedy the issue before the deal completes. Addressing risks upfront gives the buyer greater certainty and avoids the delay and expense of pursuing a claim later.
What are the key tax risk areas commonly identified in transactions?
While risks vary by sector and business size, there are certain issues that we consistently see during tax due diligence exercises and can result in material exposure if not fully understood prior to completion.
The off‑payroll working rules are complex and a frequent tax risk identified during due diligence. Each type of contractor engagement has its own set of tax rules and companies are often unaware of their obligations and compliance requirements.
In the UK, where individuals are engaged as contractors and should, in substance, be treated as employees for tax purposes, the business may be liable for historic PAYE and National Insurance contributions, together with interest and penalties.
Additional complexities arise where the individual is engaged through their own personal service company (where the IR35 rules apply) or engaged via a third-party agency or umbrella company. This is because the responsibility for determining employment status and accounting for PAYE and National Insurance contributions can sit with different parties in the labour supply chain under the legislation, increasing the risk of non-compliance and unexpected tax liabilities.
Similar anti-avoidance provisions apply to contractors and other off-payroll working arrangements in many overseas jurisdictions, exposing companies to Permanent Establishment risks, payroll and social security liabilities, and tax exposures relating to share schemes. Employer of Record (EOR) arrangements have increasingly been used to manage payroll overseas in an attempt to reduce the tax exposures, however these do not eliminate all tax liabilities.
Employment‑related securities (ERS) represent one of the most common areas of tax risk on transactions, particularly in owner‑managed and growth‑stage businesses.
ERS tax implications can be significant. Amounts expected to be subject to capital gains tax on exit may instead be reclassified as employment income, creating unexpected PAYE and employer NIC liabilities for the company.
The transaction itself can also trigger ERS events, such as acceleration of vesting and exercise of share options.
Issues frequently arise where:
- Share transactions have taken place with employees or office holders for less than market value
- Tax-advantaged share schemes such as Enterprise Management Incentives (EMI) have not been implemented correctly
- Section 431 elections were not completed on the acquisition of shares by employees or office holders, which can lead to a PAYE and employer NIC liability crystallising on a portion of the sale proceeds at completion
- Ongoing ERS compliance and reporting obligations that businesses are unaware of
Cross‑border tax risks are increasingly common, even where a business does not have an overseas subsidiary or branch.
Exposure often arises from:
- Employees and directors working internationally, creating payroll, social security or corporate tax exposures in other jurisdictions
- Cross‑border payments that have withholding tax requirements which are often overlooked
- Transfer pricing arrangements that lack appropriate documentation or commercial support
How we can help
Tax due diligence plays a critical role in ensuring that buyers understand what they are acquiring. Our findings feed directly into SPA negotiations, informing warranties, indemnities and pricing mechanisms, and reducing the risk of post‑completion disputes.
We work closely with deal teams to ensure that tax findings are reflected appropriately in the transaction documentation, whether through pricing adjustments, specific indemnities, warranty protection or pre-completion remediation actions.
Whether you are acquiring a business or making an investment, tax due diligence provides greater certainty and safeguards the long-term value of the transaction. If you would like to discuss how our transaction tax team can assist with your next deal, please fill in the form below and one of our team will be in touch.
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