(TAX UPDATE) Buying a Company? Should Financial Due Diligence Cover Tax Compliance?

(TAX UPDATE) Buying a Company? Should Financial Due Diligence Cover Tax Compliance?

Introduction

The other day, a junior staff walked into my room during a due diligence assignment.
He looked worried.
“Boss… in our due diligence work, do we check the company’s tax filings? Or only the accounts?”

I smiled.
“First rule of due diligence! Read the engagement letter.”

But the truth is, his question is common among juniors, clients, and even some advisors. Many SME buyers assume financial due diligence is only about numbers, profit, and cash flow. They forget that behind every set of accounts sits one powerful stakeholder — the Inland Revenue Board (LHDN).

And when a buyer takes over a company, they are also taking over the company’s tax history ie the good, the bad, and the “please explain” letters.

In today’s environment, tax mistakes do not disappear. With e-Invoice, data matching, and advanced analytics, even small issues can surface years later. This is why the smartest buyers check financial numbers and tax compliance before shaking hands.

This is the story we must tell every junior and every SME buyer.

Key Summary

• Due diligence is not just a financial exercise. It is a risk management tool for buyers.
• Tax compliance is one of the most sensitive areas — small errors can become large liabilities.
• Reviewing tax history helps uncover hidden exposures, penalties, and future LHDN disputes.
• The engagement letter defines the scope: tax review is included only if the buyer instructs it.
• SME buyers should request at least a high-level tax red flag review in every acquisition.
• Areas of concern often include unreported income, aggressive expenses, director benefits, capital allowance claims, withholding tax, SST, RPGT, and payroll compliance.

KTP’s View: Why Tax Must Be Part of Due Diligence

At KTP, we have seen too many deals where buyers regret not checking the company's tax history. The accounts looked perfect. The business looked stable. But a few months after acquisition, an LHDN audit letter arrived and suddenly the buyer inherited a tax bill they never planned for.

The common tax risk areas include :

1. Under-declared revenue
Cash sales, online transactions, or special arrangements may not be fully recorded. After acquisition, any adjustment becomes the buyer’s burden.

2. Disallowed expenses
Director’s personal expenses, entertainment not in line with the Income Tax Act 1967 and Public Ruling, or undocumented payments can be challenged by LHDN.

3. Incorrect capital allowances
Many SMEs simply “copy last year” without checking schedules. Overclaimed capital allowances lead to penalties and back taxes.

4. Withholding tax exposures
Payments to overseas suppliers without withholding tax deduction is one of the most common red flags. Penalties are heavy.

5. SST issues
Incorrect classification, missing registrations, or inconsistent filings can affect valuation and create liability post-acquisition.

6. PCB, SOCSO, EIS, HRDF compliance
Payroll-related exposures can be triggered by audits from multiple agencies not just LHDN.

7. Related-party transactions
Intercompany charges, loans to directors, payments to related entities, and transfer pricing risk often go unnoticed.

In many SME deals, these issues are not immediately visible. The seller may not disclose them. The accounts may not highlight them. Without a tax review, buyers walk into the deal blind.

Why Scope Matters … Read the Engagement Letter

A due diligence team is not allowed to “assume” what the client wants.
Everything must be supported by the engagement letter.

If the buyer wants a full tax review, it must be written.
If the buyer wants only financial due diligence, then tax review is outside scope.

This protects both parties the advisor and the buyer.

In practice, KTP strongly encourages buyers to add at least a tax red flag review. It is cost-effective and provides peace of mind. Even a limited scope can reveal major issues early, giving buyers the leverage to renegotiate, adjust pricing, or ask for warranties.

Why Buyers Cannot Ignore Tax Risk Today

Malaysia is moving toward a tighter compliance environment:
• e-Invoice rollout
• real-time data matching
• stricter tax audits
• increased penalties
• cross-agency enforcement

This means “old mistakes” are more likely to surface. A small issue today can turn into a large problem tomorrow … long after the sale is completed.

In mergers and acquisitions, tax exposure is no longer a side issue. It is a key item that can affect valuation, negotiation, and post-acquisition stability.

KTP’s Advice to SME Buyers

If you are buying a company, always ask your advisor these three questions:

1. Does the scope include tax review?
If not, you are taking unnecessary risk.

2. Has the seller provided all historical filings?
Missing documents are a red flag by itself.

3. Are there indicators of aggressive or non-compliant tax positions?
This affects your future bottom line.

Due diligence is not only about discovering problems. It is about protecting your investment.

Call to Action

Thinking of acquiring a company?
Need a financial or tax due diligence team who understands SME risks?

Talk to us.

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