Process of Due diligence

1. PROCESS OF DUEDILIGENCE https://taxguru.in/corporate-law/process-due-diligence.html In the times where acquisitions and buyouts are trending, the field of due diligence emerges as one of the most relevant fields. Prima facie, without delving into the technicalities of the term due diligence, the term due diligence means a process of verification, audit, and investigation of the potential investment by looking at the facts and the financial information. The process of due diligence is a continuous procedure to be carried out which is initiated right since the inception of the proposal of acquisition and goes on till the finalization of proposal into actual buyout. . The need for carrying out the due diligence has its roots from the legal concept of “Caveat Emptor” meaning “let the buyer beware”. Due diligence provides more comfort to the buyer with regards to their expectations of potential benefits and synergies enjoyed out of the investments. However, the purchase of investment without the proper due diligence gives rise to considerable risk since there may be grey areas which may not be evident per se and may significantly impact the decision of acquisition. Due diligence might further provide an affirmation to the buyer that the proposed investment confirms to the capital and operational targets and the rationale for suchinvestment. Broadly speaking, due diligence is divided into the followingcategories: Financial DueDiligence; Tax DueDiligence; Operational DueDiligence. The detailed process and checklist highlighting each of the above is asunder: A. Financial Due Diligence(FDD) Financial due diligence is done for the review period, which is decided on a case-to-case basis. Generally, review period ranges from a time of 3 to 5 years. Before starting the FDD following are the documents that should be ready for the reviewperiod: Audited Financialstatements; Unaudited Financialstatements; Cash Flowstatements; Income-taxreturns. Generally, the process starts with a comprehensive analysis of the financial statements of the target. A review of the target firm’s financing and capital structure is the foremost required. Further, analysis should include details of short-term and long-term borrowings, the debt-equity ratios , interest and fixed charges coverage ratios of the Company, the nature and extent of assets kept as collateral against borrowings and the extent of dependability of the Company’s operations on thosecollaterals. Financialduediligencealsoinvolvesanalysisofthecashflowstatement.Examinationofthequalityof company’s relationships with its lenders and an ultimate opinion concerning the reliability and credibility of its financialstatements. Anotherimportantpointistoverifywhetherthereceivablesareoutstandingbeyondanormalturnaround time and the extent of fruitful efforts made by the Company to realise its longdues;

2. Analyze the past sales trend of the Target and compare the credibility of the assumptions in the projections; AnalyzetheloanagreementsoftheTargettoevaluatewhetheranypriorapprovalisrequiredbeforesuch transaction; Whether the Budget meets the actual data or there arevariances. Whether any of the past acts of the Company was done ultra-vires the powers granted to it vide the AoA and MoA and possible implications of such acts after the acquisition ismaterialised. B. Tax DueDiligence I. DirectTax A typical direct tax due diligence entails review of relevant documents from which the tax information can be sourced. The source to obtain the relevant tax information are asfollows: The financial statements ofTarget Tax records ofTarget The scope of the tax information is asunder: Review of the contingentliability; Provision for outstanding demands recognised as presentobligations Review of tax provisions and tax paid against regular self-assessment in the balancesheet; Analysis of the effective taxrate; Review of MAT paid and MATcredit; Analysis of accumulated deferred tax assets andliabilities; The scope of the tax records is asunder: Review of Income taxreturns; Review of Tax audit reports; Withholding tax compliance; Tax depreciationclaims; Analysis of international transactions with the associatedenterprise; Review of the tax holidayexemptions; Analysis of the accumulated losses and impact of deal on suchlosses; Review of the expenses, keeping section 43B and section 40 in mind; Analysis of the past assessmentrecords. II. Indirecttax The scope of Due diligence for indirect tax is asunder: Relevant indirect tax information is normally available in the profit and loss account related schedules, notes attached to the financial statements, Auditors Report and Directors Report. The Notes to accounts disclose the contingent liability in respect of disputes against the company. The Auditor’s report discloses the details of outstanding indirect tax as well as disputed dues. Sometimes, the Director’s report includes foreign exchange earnings and outgo position and also discusses the status of ongoing taxlitigation.

3. Examining the contingent liability schedule and indirect tax provision created in books of accountsenables a reviewer to get an insight into indirect tax disputes between the company and the tax authorities. As the next step, ewer may ask the necessary questions/review relevant records to examine details of disputes between the target and the tax authorities and would then highlight the riskexposure Generally,anentityliabletopayanytaxhastoobtainappropriateregistration,payappropriatetaxesand file periodic returns under specific indirect tax legislation. The detailed tax records maintained by the company provide information regarding the indirect tax implications on the business carried out/services provided by thetarget. Thereturnsfurnishedtotaxauthoritiescontaininformationsuchastherateoftaxapplicableandthe details of exemption claimed. Typically, under indirect tax laws, goods/services are taxed based on their classification. One finds that the tax authorities often raise disputes with regard to the classification of the goods/services. Hence, the reviewer must analyse the positions adopted by the target in this regard and comment on theirtenability. ThegovernmenthasannouncednumberofexemptionsunderGST.Oftentheseexemptionsaresubjectto many conditions and prescribed procedures. A reviewer has to analyses the appropriateness of the eligibility of exemption or the procedure followed or the records maintained with respect to exemption availed in respect ofGST. Normally,taxpaidatthetimeoftheprocurementofgoodsorservicesiseligibleforsetoffagainstthe output tax liability However, various Legislations prescribe detailed criteria for the eligibility of input tax credit. During the review, tax credit availed is reviewed, and test checks are carried out to identify and report exposure ifany Recordsandreturnsarereviewedtoensurethatappropriateinputcredithasbeenavailedandutilized while discharging output tax liability and that the said liability has been paid (through credit or cash or both) on time. This also includes a review of the appropriateness of reversal of input tax credit on exempted services effected by theTarget. Authors- CA Chintan Rachh & CA PriyankaHotchandani.