Implications of modernisation of external tax audits regarding M&A transactions

To identify tax risks in the context of M&A transactions, potential purchasers usually carry out a so-called tax due diligence. In addition to other due diligence areas, the tax due diligence attempts to anticipate and assess the future risks related to an external tax audit for the target. The status of external tax audits of the respective target companies is therefore an important indication for the scope and informative value of such tax due diligence. For example, past and completed external tax audits create particular legal certainty for the audited assessment periods (“behind the firewall”). In addition, a completed external tax audit provides clues about areas where a company may be exposed to tax risks, which could also be the subject of discussions with tax authorities in the future. Pending tax audits at the time of due diligence have at this stage only limited analytical potential in the form of audit inquiries. They do not offer any partial results that would be binding on the tax officials.

At the turn of the year 2023, the legislator laid the foundations to accelerate external tax audits in the future. In this context, external tax audits for taxes arising after 31 December 2024 will be completed more quickly. In addition, it will be possible to document interim audit results in a binding manner from 2025 onwards. In the following the most important regulations and possible implications for tax due diligence processes in a classic share deal from the perspective of the purchaser are discussed.

Effective 1 January 2023, tax authorities can demand with the announcement of the audit that the taxpayer presents documents that are subject to a recording and storage obligation. On the other hand, the auditing authority is required to define the so-called audit focal points. Thus, knowing this in advance, the taxpayer may prepare to deal with the defined focal points early on and proactively. This enables the parties participating in the taxpayer's transaction to better focalise their examination procedures. 

In the case of taxes that arise after 31 December 2024, tax investigations will be handled faster. Thus, the period for which the deadline for issuing a tax assessment decision can be suspended based on audit orders is limited to five years counted from the end of the year in which the audit order was notified. This deadline is crucial in terms of the date by which tax assessment decisions can be changed. It should enable scheduling the term of an official tax investigation right at the outset. From the perspective of purchasers, this can be assessed positively as regards the scope of the risk of back tax claims. This would alleviate the sword of Damocles hovering over past periods which could become the subject of a pending tax audit over long periods of time. This will accordingly shorten the period subject to risk exposure. As tax audits will be shorter, the number of tax audit reports that can be used in tax due diligences could also increase. This, in turn, will increase the analytical potential of the due diligence risk determination. 

 

Tax audits that start in 2025 can be structured to deliver partial audit reports and partial tax assessment notices. Thus, tax bases for separate issues already investigated can be assessed separately before the tax audit is completed with regard to the remaining areas. These partial results are binding for the subsequent tax assessment notice. They thus further limit the risk of contingent back tax claims. These initially assessed back taxes would then be taken into account as debt items, which would (in part) create legal certainty already during the ongoing tax audit. This would make it possible to further limit any other indemnification agreements or purchase price retentions.

Even with no partial results yet available, it would be possible for the taxpayer to conduct regular interim discussions with tax authorities. In addition to the audit inquiries made so far, each discussion could provide initial indications for the direction in which the tax officials are heading with the pending tax audit.

In summary, it can be stated that the measures aimed at modernising external tax audits can have huge implications for the quality and analytical potential of tax due diligence processes in the future. This, in turn, would help limit tax risks for a contemplated transaction and make risks more quantifiable. Both purchasers and sellers could thus benefit from the modernisation.