Mergers and acquisitions suffered a slump right after the pandemic but are rebounding. There are tens of thousands of such deals annually in the U.S. even in a slow year (often driven lately, observers remark, by big paydays for the deals’ principals).
Yet for decades as many as three quarters or more of these deals have ultimately failed. One frequent reason: bad due diligence. And if one of the parties in the deal has past sales tax liabilities, a problem area easy to overlook in the excitement of M&A (especially when a private company is involved), the deal can hit the rocks.
What to look for
Sales tax risk liability might not grab as headlines like other kinds of a business problems, but it’s no marginal risk: As much as 10% of a business’s overall revenue could be exposed (including penalties and interest for non-compliance).
Look carefully. Due diligence should involve scrutiny of the target company’s tax background, including all returns, audit history and accounting method. Sales tax histories should get even more attention if the two companies in the M&A are in different industries.
Determine sales tax nexus. Nexus is the connection with a tax jurisdiction. Due diligence should include a thorough review of all sales activities, including transaction volumes (dollar sales figures or transaction volumes, or both, can trigger nexus in different states). Review the last 12 months’ sales to see if any individual states recognized more than $100,000, a typical nexus threshold. Nexus can also be physical, created by an office or having personnel in a state.
Review taxability and estimate exposure. Once nexus is established, determine whether a business’s products or services are subject to sales and use tax. Don’t forget the taxability of the customer base. Are they nonprofits, resellers, government entities or in some other industry that has an exemption to sales and use tax? Also consider the statute of limitations: It’s typically just three four years for a registered taxpayer who’s filing sales and use tax returns on time.
Estimate prior-period exposure. The data can help those involved in the M&A set strategy to mitigate liability. Time is a friend in these situations: Pinpointing prior-period liability before the deal gives everybody a better chance to explore mitigation.
Steps to take
Investigate mitigation. If the sales tax liability is immaterial, registration and retroactive remittance of sales taxes may get a company into compliance. A voluntary disclosure agreement (VDA) can be a way for a company to self-report back taxes owed; in exchange states generally waive penalties and limit the look-back period.
Other mitigation options include “XYZ letters” from a company to ask past customers if they’ve already paid the tax or they’re exempt on some transactions (ask for exemption documentation); and escrow settlements to handle liability expense and under which the buyer and seller agree to split the escrow equitably after a pre-determined time.
Establish a tax compliance filing process. Once a business has determined a requirement to collect and remit sales tax, they must establish a way to charge sales tax, register with each required state and set up a process for filing the sales tax returns. Many businesses look to outsource the compliance process to remove the stress and legal liability.
(Click here to download our ebook, “How Sales Tax Impacts M&A.” Listen to our webinar “Mergers and Acquisitions Case Studies & Actual Negotiations” here.)
If you want to minimize the risk of sales tax noncompliance, reach out to an expert. Contact us to learn how we partner our clients with an experienced and dedicated practitioner to ensure sales tax is taken care of.
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