Ongoing M&A Market Boom to Spur Due Diligence, Tax Consulting Services

An ongoing strong market for corporate mergers and acquisitions (M&As) should mean continued steady business for CPA firms providing due diligence and related M&A and tax consulting services, according to a report from KPMG.


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The Big Four firm’s survey of 138 senior executives at a broad cross section of multinational and middle market companies found that at least 25,000 M&As will be completed worldwide in 2006, which would be an 8 percent gain over the 23,000 completed in 2005. Sixty-six percent of the respondents said that their own companies this year are slated to complete cross-border transactions involving buying and selling entities that are based in different states or different countries.

Of interest to accountants and other M&A advisors, 70 percent of the respondents expressed concerns that unrecorded liabilities of the companies targeted for acquisition could hamper their deals, and 40 percent acknowledged the potential for incomplete pre-deal planning. Unpaid or under-reported taxes figure prominently among the unexpected M&A liabilities.

And it’s a concern in M&As of all sizes. While a good portion of the M&As addressed in the survey are among very large multinationals, 22 percent of the deals involve companies of under $500 million in annual revenues.

“The M&A market has been hot for several years and I don’t see any signs of it letting up,” says Greg Falk, principal in charge of KPMG’s M&A Tax practice. He expects the trend to mean a lot of work for his practice and for other tax and M&A advisors because, “The thing about mergers and acquisitions is that they are impacted by a lot of variables that require due diligence and planning.”

The 22 percent level of smaller deals cited in the KPMG survey may be low compared to the M&A market in general. In a 2004 interview, Roger Aguinaldo, publisher Mergers & Acquisitions Advisor newsletter, maadvisor.com, which tracks middle-market M&A activity, said that for every mega-deal closed by a well-known public company, there are 10 lower-profile transactions between private firms, from $500 million in annual sales on down.

Meanwhile, the overlooked tax liabilities are critical. Falk says that even at the state and local levels, those liabilities “can significantly diminish the overall value of a transaction.”

State and local sales and use tax liabilities can be especially troublesome. More than 7,500 entities, including 45 states and the District of Columbia, impose such taxes on purchases of tangible goods, making it very plausible for a company to fall out of compliance and owe taxes which are overlooked until due diligence or until after it is acquired by another company.

Not only is there a concern that the acquired company may owe untold millions to states where its new purchase was supposed to be collecting and remitting sales taxes on its transactions, but there’s also the potential that acquiring an entity with a physical presence in multiple states could automatically make the buying company responsible for collecting and remitting taxes in those states.

An even more prominent state tax liability involves companies’ failure to correctly apportion their income among all the states where they have operations. Falk notes, “There’s always an incentive to shift (income from) products and services to low tax rate states from high ones.” That includes shifting income reported and changing transfer pricing in which subsidiaries pay a parent company or an affiliate for services rendered or supplies.

To be sure, Falk says that federal liabilities “can be infinite”, depending on the how many acquisitions the to-be acquired company has made. “When you are an acquisitive company, you can acquire many hidden liabilities that are not always detected. Doing due diligence can be like peeling back an onion,” he says.

Small companies being purchased are often more likely to carry tax liabilities than larger companies because they often lack the internal staffs and access to sophisticated consulting service needed to stay on top of tax compliance and other potential liabilities. Falk says that when his practice does due diligence on small and middle market entities “we tend to find more issues, and more significant issues.”

State regulators reviewing M&A deals are also now more likely to uncover liabilities. Falk notes that regulators in states with financial shortfalls are in tune to rooting out liabilities because “it’s easier to generate revenue from monies already owed to you than it is by raising taxes.”

Indeed, states’ aggressiveness in pursuing missing sales and use taxes is well-known throughout the accounting profession. “There is a lot of pressure on states to find nexus and collect taxes where they legally can without raising taxes. They don’t want to raise taxes, but they all need revenue,” said George Farrah, director of state tax services for BNA Tax Management, which conducts an annual review of states’ nexus policies. Nexus is the level of presence a company must have in a state to be required to pay or collect and remit taxes there.

“When there are gray areas in trying to determine if a company should be required to collect and remit, the states are now more likely to take the position that the company should be filing,” Farrah added.

RSM McGladrey is among the non Big Four firms expecting undetected liabilities to grow among middle market and smaller companies, fueled in large part by Baby Boomer company principals who are reaching retirement age and planning to sell their interests. “If buyers and sellers don't address tax issues early on when considering a merger or acquisition deal, they could risk leaving millions of dollars on the table,” the regional firm says in a recent edition of its “Advantage” newsletter.

Meanwhile, KPMG’s survey indicates that M&A activity should continue to grow as long as corporations plan to grow. Seventy-six percent of the executives contacted identified “enhanced competitive positioning” as why their companies are doing M&As; 72 percent cited a need to access new customers and market segments and 81 percent identified a need to access new product markets.

The survey respondents predict the top three industries for M&A activity are telecommunications (44 percent); banking (30 percent) and energy (24 percent), closely followed by healthcare (23 percent); pharmaceuticals (22 percent); electronics (17 percent); consumer products (16 percent) and software (16 percent). In addition, 88 percent of those polled expect to complete at least one merger or acquisition this year (cross-border and single-jurisdiction deals), and more than 40 percent say their own organizations have plans to sell, spin-off or divest a portion of their businesses over the next 18 months.
John Covaleski

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