Between Legal Obligation and Strategic Advantage
In the SME sector, tax due diligence is often misunderstood – especially when it is viewed merely as a compliance duty to mitigate risks, ensure tax conformity, and release management from liability (e.g. under § 43 para. 1 GmbHG or § 93 para. 1 AktG). Undoubtedly, it fulfills these functions – but its true strategic value lies much deeper.
In practice, tax due diligence is one of the most effective tools for adjusting the purchase price to reflect the level of risk – in the interest of a fair balance between buyer and seller. However, this potential often goes unused when tax due diligence is seen solely as a compliance exercise.
In fact, its full strategic value only unfolds when at least three expert disciplines work in close coordination:
- Tax law, to identify and assess fiscal risks;
- Managerial and financial analysis, to quantify and evaluate those risks;
- Civil law, to contractually secure the results in the share or asset purchase agreement.
Tax due diligence is therefore not a mere tax project – but a key instrument in risk-adequate purchase price structuring.
The Tax Perspective: The Foundation of Tax Due Diligence
The tax component of a due diligence goes far beyond reviewing historical data. It functions as a pre-emptive tax audit, initiated on behalf of the buyer. The aim is to systematically identify, evaluate, and transparently disclose potential tax risks – ideally before the tax authorities do.
The analysis is conducted using a tailored checklist and covers typical risk areas in income tax, VAT, and local trade tax. In cross-border transactions, insufficiently documented transfer pricing with affiliated companies (§ 1 AStG) is also a key concern. Other risks may include unpaid withholding tax, harmful transfers of tax loss carryforwards, or formal errors in transaction structuring.
The result is a structured report that describes all material risks and, where possible, outlines a range of potential tax consequences. This provides a solid snapshot of the company's tax position, anticipates key issues of future tax audits, creates transparency for further negotiations, and influences whether value-relevant aspects were already known before signing the contract.
The outcome is a structured report that describes each relevant risk and – where feasible – provides a range of potential tax consequences. It serves as a factual snapshot of the company’s tax position, offers a qualified preview of potential audit findings, creates transparency for negotiations, and affects the legal evaluation of whether value-relevant factors were known prior to signing
In practice, however, the process often stops here. Risks are documented, but their quantification for purchase price purposes remains vague. This is precisely where managerial and economic analysis can significantly enhance the utility of tax due diligence – e.g. by applying probability models or simulations. Only by deriving quantifiable cost ranges can these risks be translated into specific price adjustments, warranties, or indemnities.
The Managerial-Economic Perspective: Quantifying Risks as a Basis for Price Negotiation
The tax analysis provides valuable substance – but the managerial-economic assessment gives the findings real negotiating power. Simply stating that a potential tax exposure may be “up to EUR 2 million” is too vague to be actionable. This is where quantification adds concrete value.
Risk quantification typically follows a structured three-step model:
- Quantification of identified risks, by reasonably estimating the potential tax impact – e.g. resulting from hidden profit distributions, transfer pricing errors, or unrecognized pension obligations.
- Assessment of each risk, by assigning plausible probabilities of occurrence. These are based on audit experience, comparable cases, or the judgment of specialized advisors. Combining the potential financial exposure with the likelihood yields an expected value per risk.
- Presentation in aggregate, either via a simple scenario analysis or – in more complex cases – through statistical simulations. The scenario analysis typically compares a best case, base case, and worst case. This method is particularly well-suited for SMEs, as it is understandable, pragmatic, and easy to communicate to stakeholders, lenders, or the seller. In situations involving numerous or particularly uncertain risks, a Value at Risk (VaR) calculation may be used to determine the probability that total exposure does not exceed a given threshold. However, the added effort is only justified in rare, highly complex transactions. Moreover, VaR requires a reliable data base, which in practice is often not available. Probability estimates tend to be subjective rather than derived from historical market data, and many tax risks occur discretely and non-linearly – which standard VaR models can only partially capture
Regardless of method, it is the managerial-economic analysis that makes tax risks numerically negotiable – whether through price reductions, contractual safeguards, or balance sheet provisions. In this way, tax due diligence becomes more than documentation: it becomes an instrument of economic control.
The Civil Law Perspective: Contractually Securing Tax Risks in the Purchase Agreement
From a buyer’s perspective, tax due diligence must not end with identifying risks – the results must be legally secured in the contract. This is typically done using tax clauses that protect the buyer from legacy tax liabilities which may arise only later through a tax audit.
Findings from the tax due diligence can be used to draft representations and warranties or indemnification clauses, depending on the legal form of the company (partnership or corporation) and the transaction structure (share deal or asset deal).
A key provision is usually an indemnity for tax liabilities relating to periods before the closing date – including secondary costs such as interest or advisor fees. To ensure legal enforceability, such clauses should include clear liability thresholds (de minimis), basket amounts, and caps. Separate thresholds often apply to tax-related guarantees, since these risks tend to involve higher monetary values.
Given that tax audits may occur years after the transaction, it is advisable to include a specific statute of limitations clause, tied not to the general legal deadline, but to the finality of the tax assessments – with a clearly defined trigger date. To ensure cooperation, the contract should also include a right of the buyer to participate in tax audits relating to pre-closing periods. Only when the identified tax risks are consistently secured under civil law can the buyer’s economic objectives in the transaction be sustainably protected.
Conclusion: More Than Just a Compliance Checkbox
In the SME sector, tax due diligence is much more than a formal review for risk documentation – it is a strategic tool for controlling corporate acquisitions. Its full potential unfolds only when tax, managerial-economic, and legal perspectives are integrated into one process. Those who not only identify risks but also quantify and contractually secure them lay the foundation for informed decisions, fair valuations, and legally robust agreements.
In mid-market M&A – where every risk counts – tax due diligence becomes a supreme discipline: both economically and legally.
Do you have questions or are planning a tax due diligence process to determine a reliable purchase price? We would be pleased to offer you an initial consultation.
