Financial and Tax Due Diligence
Diligence is not an audit and it is not a search for everything wrong with a business. It is a scoped exercise to answer one question: is the price right, and if not, what would make it right. This guide covers the core workstreams, what a report can and cannot say, and how findings actually move a deal.
- Quality of earnings, and why reported profit is the starting point not the answer
- Normalised working capital and the completion mechanism it feeds
- Debt and debt-like items
- Tax exposures, and what a buyer inherits by structure
- The independence line, said plainly
What a diligence report is, and what it is not
Due diligence is a specific-purpose engagement carried out on a scope agreed with the party commissioning it. It is not an audit, it does not express an opinion on financial statements, and it does not provide the assurance an audit opinion provides. A report that reads as though it does is misdescribing itself, and the distinction is legally significant when someone later relies on it.
Which standard governs depends on what was actually engaged for, and a diligence engagement is not automatically an agreed-upon procedures engagement. Where the engagement is limited to procedures agreed with the client and the reporting of factual findings, it is governed by the extant SRS 4400, Engagements to Perform Agreed-upon Procedures Regarding Financial Information. Where it involves evaluation, professional judgement, risk identification and recommendations, which is what most transaction diligence involves, it is ordinarily an advisory engagement and should not be described as an SRS 4400 engagement. Where reasonable or limited assurance is being expressed on subject matter other than historical financial statements, SAE 3000 (Revised) may apply instead. A report is not an agreed-upon procedures report merely because it contains a list of procedures.
One point worth stating because secondary material gets it wrong: SRS 4400 (Revised), Agreed-Upon Procedures Engagements, was issued as an exposure draft in July 2023 and remained an exposure draft as at 17 September 2026. The extant standard is the operative one and the revised version should not be cited as though it were in force.
Under the extant standard the report must say that the procedures performed do not constitute an audit or a review, that no assurance is therefore expressed, that had additional procedures, an audit or a review been performed other matters might have come to our attention, and that the report is restricted to the parties who agreed the procedures. What is reported is factual findings, not an opinion, a conclusion, or a general statement that nothing adverse was found.
So in every report we state the scope, the sources, the period covered, the procedures performed, the limitations, and that no assurance is expressed. That framing is the report's boundary and it is not decorative.
Getting from reported profit to something a buyer can pay a multiple on
Reported profit is where the analysis starts. The exercise is to establish what the business sustainably earns, which means separating what recurs from what does not, and what belongs to the business from what belongs to its current owner.
The recurring adjustments are familiar: one-off gains and losses, related-party transactions not at market terms, owner remuneration above or below a market rate, costs a private company carries that a corporate buyer will not, revenue recognised on a basis the buyer will not continue, and provisions released into profit. Each one is quantified, sourced and either agreed or disputed. A quality of earnings schedule with unexplained adjustments is a negotiating liability rather than an asset.
Two patterns deserve particular attention because they are common and consequential. The first is revenue timing that shifts around a period end, which shows up as an unusual pattern in the final month of each year. The second is a deteriorating trend concealed by a growing customer base, where the aggregate line rises while the underlying cohorts decline. Neither is visible in an annual summary, which is why monthly data is requested.
The number that quietly moves the price
Almost every deal includes a working capital adjustment, and almost every dispute after completion is about it. The buyer is entitled to acquire a business with a normal level of working capital in it; the target of the exercise is establishing what normal means, usually as an average over twelve months adjusted for seasonality and for anything non-recurring.
Three things decide whether this works. The definition of working capital in the agreement, which should exclude cash and debt items to avoid double counting and should list what is in and out rather than relying on a general description. The accounting policies applied in the completion accounts, which should be stated to be the same as those used to build the target, in that order of precedence. And the treatment of specific items that could be classified either way, such as accrued bonuses, deferred revenue and provisions, each named.
Deferred revenue is worth calling out separately. It is a liability that will be settled in service rather than cash, and whether it belongs in working capital or is treated as debt-like changes the price directly. It is worth deciding on purpose rather than by default.
What counts as debt when the agreement says cash-free and debt-free
| Item | Usual treatment | Why it is argued about |
|---|---|---|
| Bank borrowings and overdrafts | Debt | Rarely disputed |
| Finance and lease liabilities | Debt | The measurement depends on the accounting basis, which is why the basis has to be stated |
| Unpaid tax and statutory dues | Debt-like | Often omitted from a first draft and always found in diligence |
| Unfunded employee benefit obligations | Debt-like | Gratuity and leave encashment liabilities are frequently unfunded and material |
| Deferred or contingent consideration on a prior acquisition | Debt-like | Easily missed because it sits in a note rather than on the face |
| Declared but unpaid dividends | Debt-like | Straightforward once identified |
| Capital expenditure committed but unpaid | Depends | Turns on whether the buyer gets the benefit of the asset |
| Customer deposits and advances | Depends | Working capital in a business where they are ordinary, debt-like where they are financing |
The list is drafted into the agreement. Anything not on it will be argued about after completion, when the money has moved.
What a buyer inherits, and how it depends on the structure
On a share purchase, the buyer inherits the company's entire tax history, including positions taken in years still open to assessment and anything under dispute. On an asset purchase or a slump sale, the inheritance is narrower but not nil, and the specific carve-outs matter.
The workstream covers open assessments and appeals with their amounts and stages, positions taken that are aggressive rather than settled, withholding tax compliance, transfer pricing where there are related-party dealings across a border, indirect tax registrations and filings, and any incentive or concessional regime the target relies on, together with what happens to it on a change of control.
Carried-forward losses are often the single largest tax number in a diligence on a loss-making target, and they are the number most often assumed rather than tested. Section 119 of the Income-tax Act, 2025, which carries forward the substance of section 79 of the 1961 Act and applies from tax year 2026-27, ordinarily permits a company in which the public are not substantially interested to carry forward an earlier loss after a change in shareholding only where persons who beneficially held shares carrying at least fifty-one per cent of the voting power on the last day of the loss year still beneficially hold at least fifty-one per cent on the last day of the set-off year. The test is on beneficial voting power rather than registered ownership or economic interest, and it has to be applied separately for each loss year.
The start-up carve-out survives, in section 119(3)(b), and it is a different test rather than a relaxed percentage. An eligible start-up referred to in section 140 may carry the loss forward irrespective of percentage dilution, provided all shareholders who held shares carrying voting power on the last day of the loss year continue to hold those shares on the last day of the set-off year, and the loss arose within the ten tax years beginning with the year of incorporation. New investors can be admitted without breaking it; an existing shareholder from the loss year selling out breaks it. Recognition by the department for promotion of industry and internal trade is not by itself enough where the section 140 conditions and certification have not been met.
The section preserves specified exceptions, including a transfer on the death of a shareholder, a gift to a relative, a change in an Indian subsidiary following the amalgamation or demerger of its foreign parent where fifty-one per cent continuity is maintained, a change under an approved resolution plan under the Insolvency and Bankruptcy Code, specified tribunal-approved plans where the board was suspended under sections 241 and 242 of the Companies Act, and qualifying strategic disinvestments. The practical consequence for diligence is that the loss schedule is analysed loss year by loss year, reconciling assessed and returned losses against the beneficial voting power at each year end and every allotment, transfer and conversion since. A single statement that the target has accumulated losses is not a finding.
The going-concern exemption, and the liability that travels with the business
A transfer of a business as a going concern is exempt from goods and services tax. The entry is serial number 2 of Notification No. 12/2017-Central Tax (Rate) of 28 June 2017, covering services by way of transfer of a going concern, as a whole or an independent part thereof, at a nil rate with no condition attached.
That entry was confirmed present in the notification as originally issued, read 1 September 2026. It has not been re-confirmed against Notification 16/2025-Central Tax (Rate) of 17 September 2025, which amended Notification 12/2017 as part of the rate reset following the 56th Goods and Services Tax Council meeting. The exemption is valuable enough that it is worth confirming against the current consolidated notification rather than assuming, particularly where the transaction has been structured around it. That check is on our own review register and this page will be corrected if the position has moved.
The exemption is about the supply. The liability is a separate question and it travels with the business. Where a taxable person transfers a business in whole or in part, by sale, gift, lease, leave and licence, hire or any other means, section 85 of the Central Goods and Services Tax Act, 2017 makes transferor and transferee jointly and severally liable for the transferor's tax, interest and penalty for the period up to the date of transfer, whether the amount was determined before or after that date. Where only part of the business is transferred, the transferee's exposure is limited to the extent of that transfer. A demand raised after completion for a pre-completion period can therefore still be recovered from the buyer. A contractual tax indemnity allocates the economic burden between the parties; it does not stop the authorities invoking the statutory liability.
Section 85 does not draw a line between a going concern transfer and an asset sale. The question it asks is whether a business, or an identifiable part of one, has been transferred, so an itemised asset sale that in substance moves an operating business can attract it. What differs between the two structures is the treatment of the transfer itself: a qualifying going concern transfer is exempt, while an itemised asset sale is ordinarily taxable asset by asset. Under section 85(2) the transferee is liable for tax on supplies from the date of transfer and must amend its registration, and section 22(3) separately requires registration from that date. Where the arrangement carries a specific provision for the transfer of liabilities, section 18(3) read with Rule 41 allows unutilised input tax credit to move across on Form GST ITC-02, which the transferee must accept on the portal.
Due diligence, audit and internal audit are different engagements
Financial due diligence is a transaction-driven, non-assurance exercise commissioned by a party to a deal. Statutory audit is an assurance engagement owed to the members. Internal audit and forensic audit are governance and investigative engagements, and we treat those separately on our audit and assurance pages, where they belong.
The independence line is not a formality. Where a firm holds an assurance relationship with a party, the transaction work it can accept for that party or against it is constrained, and the constraint is a professional obligation rather than a preference. We check the position before accepting an engagement and say so if there is a conflict, rather than managing one quietly.
Questions about diligence
What is vendor due diligence, and is it worth it?
It is diligence commissioned by the seller before a process starts, made available to bidders. On a competitive sale it is usually worth it: it shortens the process, reduces the number of separate exercises being run over the same data room, and surfaces problems while the seller still has time to fix them rather than discount them.
How far back should diligence look?
Three years of financial information as standard, monthly for at least the most recent two. Tax goes back as far as assessments remain open, which is longer and is set by statute rather than by preference.
Can diligence findings be covered by insurance instead of an indemnity?
Sometimes, through warranty and indemnity insurance, though an identified issue is typically excluded from cover rather than included. It is covered further in guide 3, where its Indian availability is one of the open points.
Where to go next
Transaction Advisory Services
Back to the main page: what we do on a deal, how an engagement is structured, and how to reach us.
Preparing for a Transaction: Structures and Approvals
The structuring choice made before anything else, and the approval map that follows from it. Share purchase, asset purchase, slump sale, scheme of arrangement and the fast-track route that got considerably wider in 2025.
Buy Side and Sell Side Execution
Running the process: information, term sheet, definitive agreements, warranties and indemnities, conditions precedent, completion mechanics and the integration that starts on day one rather than after it.
Fundraising: Equity, Debt and Capital Markets
Private rounds, the rewritten external commercial borrowing framework, and what changes when the route is public markets, including the tightened small and medium enterprise listing regime.
Restructuring, Distressed Deals and Exits
Resolution outside insolvency under the Reserve Bank's 2025 directions, transactions under an extensively amended Insolvency and Bankruptcy Code, carve-outs, and the exit routes with their current tax treatment.
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Tell us the target, the structure and the timetable, and we will scope the exercise against what could actually change your decision rather than against everything that could be examined.
Position as at 17 September 2026. Reviewed every six months.
This page is general information, not professional advice. Transaction law and transaction tax in India both moved substantially between September 2025 and April 2026. The fast-track merger route was widened, the external commercial borrowing framework was rewritten, the Reserve Bank replaced its stressed asset framework, the Insolvency and Bankruptcy Code was amended extensively, and the taxation of a share buyback changed for the second time in eighteen months. Every position on these pages was reviewed by a qualified professional in September 2026 and carries the date it was confirmed. Take professional advice before acting on anything on this page. We are happy to be that adviser, but we do not act on a web page, ours or anyone else's, without one.