Many aspects of a target company’s tax history can pop up – often unpleasantly – during the due diligence of an M&A. And though perhaps not the first tax to mind when looking into problematic pasts, sales tax can torpedo a promising deal.
In the last 15 years or so, awareness of sales tax in M&A has intensified. The prospective buyer takes the understandable step of rooting for every red flag for past, potential sales tax problems with states, bringing in analysts and researchers who start looking for the easy findings and start making a lot of broad assumptions about the prospective seller’s past sales tax problems.
These findings could hurt the asking price or tank the deal. At best the prospective buyer might want to secure against the risk via escrow and demand the past risk be mitigated.
Do you the buyer know what to look for in potential past problems? Are you a seller prepared to defend or improve your past sales tax position?
Decision tree for sales tax obligations
Assessing sales tax exposure and liability in due diligence hinges on determining where a company has or has had sales tax obligations. Generally, did the company in question charge, collect and remit the correct amount of sales tax money to the tax jurisdiction?
Nexus: This can, for sales tax purposes, be a physical or economic connection between a company and a state/jurisdiction that allows the latter to impose sales tax laws. Without nexus, a company has and has had no obligation to comply with those laws.
Physical nexus has historically been what most companies created with an office, employees, installation service contractors or inventory housed in a state. Economic nexus has been much more widespread since the 2018 U.S. Supreme Court decision in Wayfair, which ruled that states could mandate sales tax collection and remittance obligations on an out-of-state company. States have set their own (and widely differing) economic nexus rules depending on volume and dollar amount of sales. Many states still adhere to around $100,000 in annual sales (gross or retail, depending on the state) but states, such as Indiana and a number of others, have started to eliminate threshold counts when calculating economic nexus.
(We recommend that once a company hits or has hit $100,000 in annual sales in a state, it considers carefully whether it has a sales tax nexus in that state.)
Seller companies might also have responsibility from transaction taxes even in the NOMAD states that don’t have a statewide sales tax; local tax jurisdictions in home rule states such as Colorado, Alabama or Louisiana can also impose their sales tax rules on companies that have unknowingly created nexus.
Taxability: Did the seller company provide a taxable product or service in a state? Again, no nexus, no questions of taxability. And again, like nexus, taxability differs by state with many nuances.
Generally, sales tax statues mention the retail sale of tangible personal property or enumerated services, such as telecom. This can create unforeseen nexus for a variety of companies, especially tech firms that have software downloaded all over the country (quickly pushing a company past economic nexus standards).
Services are generally excluded but are becoming taxable in some states, especially services such as installation, maintenance and SaaS.
Situs: The situs is the location in which a taxing event occurs or where ownership of the TTP transfers. This is typically driven by where the title of the sold item transfers, where the customer receives the benefit of the product or service.
Again, with SaaS, to name one tech field, the situs question can quickly become complicated.
Estimating exposure
What is the past exposure to catch up on in M&A due diligence?
Start with that $100,000 rule of thumb to see where a company has had nexus. Then look at the taxability of that company’s products or services, whether the company registered for sales tax in the state and the frequency of filing of sales tax returns (which can vary by state).
How big a problem do you have?
Let’s say you’re looking at having had nexus in a state with the statewide and local sales tax rates are a combined 8% to 9%. How much revenue did the company have in that state? That’s the potential assessment, plus penalties and interest.
Almost certainly enough liability to make any buyer in an M&A think twice.
Next time, we’ll look at how a buyer or seller can mitigate past sales tax liability before a deal.
(Hear real-world examples on our M&A webinar.)
If you think your business may be impacted by sales tax developments, contact TaxConnex. TaxConnex provides services to become your outsourced sales tax department. Get in touch to learn more.
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