Tax Due Diligence: Common Exposures Found in Indian Startups and SMEs

Tax due diligence looks for past tax positions that could turn into demands after a deal closes. In Indian startups and SMEs, the same exposures come up again and again. This guide lists the most common, and how deals deal with them.

TDS

• TDS not deducted on payments to contractors, professionals, landlords or foreign vendors.
• TDS deducted but deposited late, attracting interest.
• Payments to non-residents, like overseas software subscriptions or services, without considering withholding tax.

Non-deduction can also lead to disallowance of the expense, increasing taxable income.

GST

• Input tax credit claimed without supporting supplier filings.
• Credit on items that are blocked under GST law.
• Tax not paid under reverse charge, for example on certain imported services.
• Export of services claimed without meeting the conditions.
• Mismatches between GST returns and books.

Income Tax

• Expenses at risk of disallowance: cash payments above limits, late employee PF contributions, unpaid dues under Section 43B.
• Share issues at prices that raise questions about valuation, particularly for earlier years.
• Unexplained credits or loans in the books.
• Pending assessments and notices.

International and Group Transactions

• Transactions with a foreign parent or subsidiary without transfer pricing documentation.
• Intercompany services, royalties or cost recharges without agreements.
• Founders or staff abroad whose activities may create a permanent establishment for a foreign group company.

Employee Taxes

• Incorrect TDS on salaries, including perquisites and ESOPs.
• Professional Tax not deducted or paid.

How Deals Handle Tax Exposures

• Quantified exposures reduce the price, or are covered by a specific indemnity.
• Part of the price may be held in escrow until time limits for assessment pass.
• Fixable issues, like filing pending returns, become conditions before closing.
• Sellers give tax warranties, qualified by what they disclose.

Getting Help

Think Filing performs tax due diligence on Indian businesses, quantifies exposures, and helps founders fix issues before they come up in a deal.