Sorting Out Who Owed What After a Family Member's Fix

The situation

The letter from the tax authority had been sitting in a drawer for four months by the time Carmela's deal counsel found out about it, and by then her cousin Marco had already called the seller's bookkeeper twice trying to sort it out himself, which was the real complication we were retained to address. Carmela ran a chain of clinics she had built over fifteen years, and she was in the process of acquiring a specialty manufacturer in Niagara Falls, run by Somchai, whose company made precision components used in medical and industrial equipment. The deal, valued somewhere between fifty and eighty million dollars, was well into due diligence when the letter surfaced during a routine review of the target's tax filings.

The letter was a review notice from the tax authority questioning research and development tax credit claims Somchai's company had filed over the previous several years, credits that had reduced the company's tax owing by a meaningful amount and had been treated, reasonably enough, as part of its normal profitability. If the credits were disallowed on review, the company would owe back the amounts claimed, with interest, a liability that did not show up anywhere on the balance sheet because nobody had flagged it as a live risk.

Marco, Carmela's cousin, is a commercial landlord with decades of experience managing his own tax filings and disputes over his rental properties, and when Carmela mentioned the letter to him socially, he offered to help, confident the situation was straightforward. He called Somchai's bookkeeper directly, suggested a specific way of characterizing some of the underlying research work to the tax authority that he believed would resolve the questions favourably, and encouraged the seller's team to respond along those lines before the acquisition's own advisors had reviewed the claims or the correspondence at all.

By the time Carmela's deal team learned what had happened, the seller's bookkeeper had already sent a partial response to the tax authority incorporating Marco's suggested characterization, a response neither Carmela's tax advisors nor Somchai's own external accountant had reviewed first, and one that, on a closer look, rested on a description of the research work that did not match the technical file the credits were originally supported by, a mismatch that would matter a great deal once the review moved past its opening questions.

What the review found

Research and development tax credits reward companies for eligible research and experimental development work, and the credit claimed depends on how the underlying activity is characterized and documented at the time the work is done, not reconstructed or reframed after the fact. When our tax counsel reviewed the technical file behind Somchai's claims, alongside the response Marco had already prompted the bookkeeper to send, two separate problems emerged rather than one, and each needed a different kind of fix.

The first was the underlying exposure itself. A portion of the claimed credits, roughly in the low seven figures cumulatively across the years under review, rested on work that had genuinely eligible components mixed together with routine engineering and testing that likely did not qualify under the criteria the credit program applies. This is a common outcome in these reviews: eligible and ineligible activity often sit inside the very same project, performed by the same engineers on the same timeline, and separating them accurately after the fact requires contemporaneous technical documentation that not every growing manufacturer keeps as carefully as a tax review will later demand of it.

The second problem was Marco's response letter, and in some ways it was the more urgent one to fix. The characterization he had suggested, offered in good faith to defend the claims, actually described the research activity in broader terms than the original technical file supported. That mismatch risked reading to the tax authority as an inconsistency between what was claimed at the time the work was done and what was now being argued in its defence, and reviewers tend to treat that kind of shifting explanation with more suspicion, not less. Rather than closing down the review as Marco had hoped, the informal response had introduced a new question about the credibility of the company's own account of its work, on top of the original technical question about eligibility.

None of this made the underlying business unsound, and it was important to keep that distinction clear for both sides through the negotiation that followed. Somchai's company remained a legitimate, profitable manufacturer, and the credits genuinely claimed for real qualifying work were not in serious doubt. But the size of the disallowance risk, layered onto a response that now needed to be walked back carefully without contradicting itself outright, meant the exposure could no longer be treated as a rounding error in a deal of this size, and it could not simply be left unaddressed for whichever party happened to be filing returns after closing.

What we did

1. Paused any further correspondence with the tax authority. Our first step, before anything else, was making sure nobody, including Marco, sent anything further to the reviewer until the technical file and the existing response had been properly assessed, since a second inconsistent letter arriving before the first was understood would have made the credibility problem meaningfully worse rather than better.
2. Retained an independent tax specialist to assess the claims. We brought in counsel focused specifically on research credit disputes to review the original technical documentation project by project, separating the components with strong contemporaneous support from those where the eligibility case was genuinely weak, giving both sides a realistic, evidence-based range for the exposure rather than a guess built on anxiety about worst-case numbers.
3. Reviewed and carefully corrected the informal response already sent. Working closely with Somchai's own accountant, we prepared a follow-up submission to the tax authority that reconciled Marco's broader characterization with the original technical file as honestly as the record allowed, addressing the inconsistency directly, on the record, rather than letting it sit unresolved and compound through the rest of the review as later correspondence built on top of it.
4. Quantified the exposure for negotiation purposes. With the specialist's project-by-project assessment in hand, we built a defensible range for the potential clawback, including interest, that both Carmela's team and Somchai's advisors could actually work from, replacing the earlier open-ended uncertainty, which had been driving anxious speculation on both sides of the table, with a specific number the deal could actually be negotiated around.
5. Negotiated a contractual allocation of the risk. Rather than asking Somchai to bear the full exposure alone or asking Carmela's company to absorb it silently after closing, we negotiated a specific indemnity covering the disallowance risk on the weaker portion of the claims, with a cap and a time limit tied to how long the tax authority's review process typically runs in practice.
6. Built in an escrow to secure the indemnity. We negotiated a holdback of part of the purchase price into escrow for the duration of the review, so Carmela's company had a real, funded source to draw on if the credits were ultimately disallowed, rather than relying on Somchai's post-closing willingness or financial ability to make good on the indemnity years later.
7. Set clear terms for who controlled the ongoing review. The purchase agreement gave Somchai the right to control the response to the tax authority up to a defined point, since he and his team understood the original research work best, with Carmela's advisors retaining approval rights over anything filed, closing the exact coordination gap that had allowed an uncoordinated response to go out in the first place.
8. Documented lessons for future filings inside the combined company. Once the deal closed, we helped put a simple internal process in place for how any future regulatory correspondence involving the acquired business would be routed and reviewed before response, so a similar situation could not recur inside the newly combined organization the next time a regulator's letter arrived, whoever happened to open the mail that day.

The outcome

The acquisition closed with the research credit exposure addressed by contract rather than left as an open question hanging over the newly combined company. A portion of the purchase price, in the mid six figures, was held back in escrow specifically against the disallowance risk, and Somchai accepted an indemnity capped at an amount reflecting the specialist's assessment of the weaker claims, not the full original credit amount, which both sides' advisors ultimately agreed was a fair allocation given how much of the underlying work was genuinely eligible research.

This was a negotiated compromise, not a clean win for either side, and it is worth being plain about what each side gave up. Carmela's company took on some residual risk if the tax authority ultimately disallowed more than the escrow was sized to cover, and closed later than originally planned while the exposure was sorted out. Somchai gave up a real slice of his proceeds to the holdback and accepted a longer tail of exposure through the indemnity than he had wanted, for a deal he had considered essentially finished before the review letter surfaced. Marco's early intervention had cost the deal several additional weeks of review and a harder negotiation than the underlying tax issue alone would likely have required, an avoidable cost, and one Carmela was candid with him about afterward without making it personal.

The tax authority's review concluded roughly eight months after closing, disallowing a portion of the credits within the range the specialist had projected before the deal closed. The escrow covered the resulting liability without further dispute between the parties, and the allocation held exactly as negotiated. That is the most any contractual risk-sharing arrangement can really promise in a situation like this: not that the underlying problem disappears, but that both sides know in advance, in writing, who pays for it if it does not resolve in their favour.

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