Koro Villalonga
TAX LAW DIVISION
Recently, the Central Economic-Administrative Court (TEAC) issued a decision in which it concluded that the Tax Administration is entitled to require the submission of due diligence reports within the framework of a limited audit procedure. In the specific case decided by the TEAC, the Tax Authority required the acquiring company to provide a due diligence report that was mentioned in the public deed through which it acquired all the shares of another company.
The TEAC justifies the validity of this request mainly because it considers that due diligence reports have “clear” tax relevance. This clarity is due to the fact that these reports contain a large amount of data of different kinds, among which there will undoubtedly be information with tax relevance.
Likewise, it is ruled out that the request must explicitly justify what the tax relevance of the reports is. The requested information “in itself shows the tax significance it entails,” so it would not be necessary to explain the reasons for requesting it. However, it should be noted that in the disputed request it is stated that the submission of these reports is “necessary” for the Tax Administration. This is highly questionable, since the failure to submit these reports would not prevent the Administration from carrying out its work.
Tax legislation does not define what a due diligence report is, nor what content it must include, leaving this more or less to the free discretion of whoever drafts it. Moreover, such reports often include subjective considerations regarding certain contingencies in order to influence the final purchase price, exaggerating or minimizing potential risks. It would be more appropriate, due to their objectivity and because they are less harmful to the taxpayer, to require—where appropriate—the submission of other documents (bank statements, invoices, etc.).
It is therefore completely disproportionate to request these due diligence reports, thus taking advantage of the work done by advisers and technicians, in the hope of detecting problematic tax situations. In addition, by not having to explicitly state the tax relevance of the requested reports, we may face requests with dubious reasoning, whose validity would nevertheless be endorsed by this TEAC decision.
On the other hand, the acquiring company argues that the reports contain sensitive and confidential information, and that many professionals are involved in their drafting, who have access to this information due to their duty of confidentiality and professional secrecy. It therefore claims that
submitting these reports would be contrary to compliance with those duties. However, the TEAC states that the request was sent to one of the parties involved in the purchase, to whom professional secrecy would not apply. This argument would, where appropriate, correspond to the “professionals involved in preparing the document if they had been the ones required to provide it.”
Nor does it analyze the duty to preserve the reports, nor the length of time for which they must be kept. The TEAC states that this is not relevant to assessing the validity of the request, but could be raised in a possible sanctioning procedure for failure to comply.
It should be borne in mind that this decision does not establish binding doctrine, since it is not a criterion repeatedly upheld by the TEAC. And, of course, it cannot be ruled out that, in the event of a contentious-administrative appeal, the courts will contradict this Tribunal. Some ways in which this decision could be challenged have already been outlined in this brief article. In any case, for the time being, the door is opened for tax authorities to request due diligence reports, so extreme care must be taken with what is stated in them.
