Mitigating the unseen: Why tax due diligence is critical when acquiring an Australian entity

Comprehensive tax due diligence (TDD) is not merely a box-ticking exercise – it is an indispensable risk-mitigation strategy. In addition to identifying tax risks that could impact the consideration paid for a target, there are also hidden risks that prospective purchasers must consider before closing the deal.

The peril of the open audit window

A common misconception is that historical tax risks eventually “expire”. Under Australian law, the Commissioner of Taxation generally has a four-year window to amend income tax assessments and a three-year window for fringe benefits tax (FBT). States generally have 5 years to amend.

However, these statutory clocks only begin to run once a return is lodged. If a target entity fails to lodge an income tax return, a Business Activity Statement (BAS), a FBT, or a state’s tax return for a particular period, the audit window remains open indefinitely. Furthermore, in cases where there has been fraud or evasion, these time limits are waived entirely. 

Substantiation and the long tail of capital gains

The quality of a target’s record-keeping is a direct indicator of future tax leakage. While Australian law generally requires businesses to maintain records for five years, Capital gains tax (CGT) assets are a notable exception. Records for these assets must be retained indefinitely to substantiate the “cost base”.

If a purchaser cannot verify historical acquisition costs due to poor records, they potentially face a significantly higher tax bill upon a future exit.

Turning findings into protection: The SPA

The insights gained from TDD do more than just inform the purchase price; they provide the ammunition needed to draft a robust Share Sale and Purchase Agreement (SPA). While tax warranties are standard for eliciting disclosures, they are often insufficient for high-risk exposures identified during the due diligence process. In such cases, a specific tax indemnity is essential to provide a direct mechanism for recovery should any of the above “hidden risks” manifest after the deal closes.

The bottom line

In the Australian market, what you don't know can hurt you. A rigorous TDD, backed by sophisticated legal protections in the SPA, ensures that the purchase price reflects the true economic reality of the target, and gives purchasers the ability to safeguard their investment from the hidden costs of non-compliance.

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Tony Nunes has over 25 years’ experience in providing tax advice to clients, especially on issues affecting cross-border transactions, acquisitions and restructures, and on all aspects of structuring the ownership and financing of corporations and their operations. 

Charm Jayatileka is a qualified lawyer. She specialised in corporate law in Sri Lanka, a fellow Commonwealth country, prior to commencing her career in tax in Australia. Charm works with SMEs and high-net-worth individuals from diverse industries. Her areas of tax expertise include tax residency, cross-border transactions, and capital gains tax.