Tax Due Diligence

A statutory audit checks whether financial statements show a true and fair view. A tax advisory opinion answers a forward-looking question about a proposed step. Tax due diligence is different from both: it examines a target's tax history to establish what a buyer would inherit, across direct taxes, GST and other indirect taxes, transfer pricing, cross-border positions, employee taxes, and open litigation. The output is not an opinion on a return but a record of exposures, quantified and ranked, that feeds the price, the agreement, and the deal structure. We scope each review to the transaction and its materiality threshold.

The deal structure decides how much tax history the buyer takes on. In a share purchase the buyer acquires the company itself, so the target's past tax liabilities, open assessments and disputes travel with it, including ones not yet surfaced. In an asset or business purchase the buyer can select the assets and liabilities it takes, which isolates much of the historic exposure, though a slump sale carries its own tax cost for the seller under Section 50B [ITA 2025: s. 77]. Due diligence matters most in a share deal, where unknown liabilities become the buyer's problem. We map which exposures pass under the chosen structure.

The review period is set by how long the tax authorities can still act. Under Section 149 [ITA 2025: s. 282], the legacy notice limits are 3 years and 3 months, or 5 years and 3 months for the extended Rs 50 lakh category, measured from the end of the relevant assessment year; the corresponding show-cause limits are 3 years and 5 years. Under the 2025 Act, the notice limits are 4 years and 3 months, or 6 years and 3 months for the extended Rs 50 lakh category, from the end of the relevant tax year; the corresponding show-cause limits are 4 years and 6 years. We set the diligence look-back by the applicable regime and risk facts rather than a fixed number of years.

Withholding defaults are among the most common findings. For specified resident payments, Section 40(a)(ia) [ITA 2025: s. 35] disallows 30% where tax was not deducted or deposited as required; for specified non-resident payments, Section 40(a)(i) [ITA 2025: s. 35] can disallow the full amount. Short deduction, deduction under the wrong section and late deposit can also carry interest, penalty and deductor-in-default exposure. We test the target's withholding records against its expense ledger and quantify the exposure a buyer would carry.

On the indirect-tax side, input tax credit is the usual problem area. Credit can be denied or reversed where a supplier has not filed its return or paid the tax, where the target's records do not reconcile with the auto-populated GSTR-2B statement, or where credit was claimed on blocked or ineligible items. Reversal carries interest, and credit can be blocked under Rule 86A. We reconcile the target's claimed credit with the portal data and the books, flag the mismatch that may have to be reversed, and quantify the exposure for the period still open to the GST authorities.

A change of ownership can affect the tax attributes a buyer is paying for. Under Section 79 [ITA 2025: s. 119], persons holding at least 51% of the voting power in the loss year must generally continue to hold at least 51% in the set-off year, subject to the provision's startup and other exceptions. Unabsorbed depreciation is treated separately under Section 32(2) [ITA 2025: s. 33(11)]. We test whether the target's carried-forward losses and depreciation survive the proposed transaction, since a deal can quietly extinguish tax attributes.

Where the target has cross-border dealings, due diligence checks withholding on payments to non-residents under Section 195 [ITA 2025: s. 393(2)]. It also examines indirect-transfer exposure where shares or interests in a foreign entity derive their value substantially from assets located in India, under Section 9 [ITA 2025: s. 9]. It checks place of effective management, which can make a foreign company resident in India, under Section 6 [ITA 2025: s. 6]. These positions can create unexpected Indian tax and reporting obligations, affect the deal structure and contractual allocation of exposure, and leave liabilities that a buyer may inherit.

Workforce-related taxes carry their own exposures. Employee stock options are taxed as a perquisite when exercised, with tax deducted at source on the perquisite value under Section 192 [ITA 2025: s. 392]; gaps in this deduction are a common finding. The review also covers perquisite valuation, secondment and cross-charge arrangements for seconded staff, and provident fund and ESI compliance. We check that employment-related deductions were computed and deposited correctly, since these liabilities continue with the company in a share deal.

Due diligence catalogues every open proceeding rather than re-arguing it: the notices received, the forum each matter sits at, the amount in dispute, and the amounts already paid as pre-deposits or under protest. Each is assessed as a likely liability, a possible one, or remote, so the buyer can see what should be provided for and what belongs in the contingent-liability note. Because tax disputes in India can take many years to reach finality, an unresolved matter can sit on the books long after completion. We quantify the disputed demands and flag those that warrant a specific indemnity.

Findings are only useful if they are sized. We build an exposure matrix that records each issue, the tax, interest, and potential penalty attached to it, the years affected, and the likelihood of the exposure crystallising. Issues below the agreed materiality threshold are noted but not pursued in detail, so attention stays on what can move the deal. This separates a certain liability, which usually affects the price, from a contingent one, which is better handled through a warranty or indemnity. The matrix gives the buyer a single, ranked view of the tax risk being acquired.

These are three ways to allocate a tax exposure between buyer and seller. A tax warranty is the seller's assurance that a stated position is correct, with the buyer able to claim damages if it proves wrong. A tax indemnity is a specific promise to reimburse the buyer, rupee for rupee, for an identified liability if it materialises, and often covers a known dispute. A price adjustment reduces the consideration upfront for an exposure that is certain or readily quantifiable. Which tool fits depends on whether the exposure is certain, probable, or merely possible. Our findings indicate which mechanism suits each issue.

Vendor, or sell-side, due diligence is a review the seller commissions on its own business before going to market. It surfaces tax exposures early, so the seller can correct compliance gaps, prepare explanations, and avoid surprises that erode value or stall the deal during the buyer's review. It also gives prospective buyers a credible, organised starting point, which can shorten the transaction. We prepare a vendor due diligence report that sets out the tax position candidly, since issues a buyer finds late tend to cost more in both price and trust.