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published on 14 September 2021 | reading time approx. 3 minutes
byJulia Bader
Tax due diligence often focuses on identifying special issues in the assessment period and examining them for how they were handled for tax purposes and whether there are any tax risks for the acquirer. Of course, issues such as previous restructuring measures, contracts between associated enterprises or sales of real estate may have VAT implications. However, greater risks from a VAT perspective often arise from “normal” day-to-day business, which often receives little attention during tax due diligence. For example, an incorrectly programmed ERP system or missing compliance guidelines in mass business can quickly result in a multitude of errors that could lead to high risks and additional VAT payments during the next tax audit. This article is intended to provide a sample selection of possible audit points in order to limit VAT risks arising from day-to-day business.
If the target company sells products or provides services in the case of which it is not clear whether they are subject to the standard or a reduced VAT rate, it is worth asking in the Q&A round how the VAT rates are determined. A risk exists in particular if the company incorrectly assumes that its products or services are subject to a VAT rate lower than they should. If a company is not sure what VAT rate it should use for its products, it can obtain a non-binding tariff information (German: unverbindliche Zolltarifauskunft, uvZTA). If the target company can present such uvZTA, the risk is usually low.
If the target company uses VAT exemptions, it must be able to prove that the conditions for these exemptions are met. Commonly applied VAT exemptions are for cross-border supplies within the EU (intra-Community supply) or to a third country (supply of goods for export). In this case, the target company should be able to demonstrate during the due diligence that it has a process in place ensuring that accounting and documentary evidence for all VAT-exempt supplies has been collected in full and could be presented to the tax authority. If the accounting and documentary evidence has not been produced in full, there is a risk of losing the VAT exemption for all intra-Community supplies and export supplies that cannot be fully documented. In addition to the documentary evidence, intra-Community supplies may only be carried out on a VAT-free basis if the customer uses a foreign VAT identification number valid as of the date of the supply, which must be checked and documented by the supplying company in a qualified manner. The audit and documentation process should be investigated as part of tax due diligence.
Even if the target company is generally entitled to (full) input VAT deduction on the basis of its output sales that do not affect the right to deduct input VAT, the input VAT deduction can only be claimed if the purchase invoices contain all the mandatory details required under § 14 (4) of the German VAT Act (UStG). If purchase invoices contain errors and input VAT deduction is nevertheless claimed, this can be challenged during a tax audit and the company may be required to pay input VAT back to the tax authority plus interest. Although it is possible to obtain corrected invoices, this only works if the company issuing the invoice still exists, and often has no retroactive effect. In order to prevent risks, the target company should have a process established in its accounting department (e.g. checklist) to check purchase invoices for correctness.
If the target company deducts input VAT arising from rental payments because the landlord renting out the office or warehouse space has opted for VAT, a proper rental (long-term) invoice must also be available for the input VAT deduction or the rental contract itself must contain all the mandatory details required under § 14 (4) UStG. If information is missing in the contract and there is no invoice, there is a risk that the tax authority will deny all input VAT amounts deducted from the rental payments. Although the rental agreement can be supplemented, in some cases, this will not have any retroactive effect, so interest on back taxes may be due. Tax due diligence should thus also focus on checking the rental agreements for this aspect.
In order to protect the acquirer of a company from VAT risks and possibly high back tax payments, tax due diligence should not only examine "special issues", but also "normal" transactions made in day-to-day business, which can quickly lead to considerable VAT risks, especially in mass procedures.
Tim König
Associate Partner
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