Wayfair decision having an impact on consumer and retail M&A: Watch for unforeseen sales tax liabilities
As retail and consumer companies continue to navigate through the COVID-19 pandemic, many merger and acquisitions (M&A) transactions are occurring as buyers and investors are seeking opportunities to acquire brands and businesses at favorable prices, as well as direct-to-consumer businesses that are primed for post-pandemic growth. When acquiring direct-to-consumer businesses, buyers must be mindful of potential sales tax liabilities that can arise either during the diligence process (if diligence is performed) or post-transaction, when sales tax notices start arriving. As the pandemic complicates usual M&A processes, remember to also factor in the newer considerations stemming from the U.S. Supreme Court holding in South Dakota v. Wayfair, Inc.
As a result of Wayfair, decided on June 21, 2018, the long-standing physical presence standard for imposing sales tax on out-of-state businesses was overturned. Previously, an out-of-state business had to have a physical presence in a state (i.e., employees, office, inventory) in order for the state to be able to require the business to collect and remit sales tax. With the new Wayfair standard, an out-of-state business that meets a certain threshold based on either the number of transactions or dollar amount of transactions to in-state customers will be required to collect and remit sales tax on taxable sales. Generally speaking, the state thresholds under Wayfair are 200 or more transactions or $100,000 or more of in-state sales, on an annual basis.
While this new nexus standard may result in a business having to collect and remit sales tax in additional states, it also creates additional risks for buyers of a business. Whether a transaction is structured as an asset or stock deal, identifying potential sales tax exposure at the target company is critical since undisclosed sales tax liabilities may succeed to the buyer. Consider these key issues during a due diligence review.
- A selling company’s sales tax liabilities may attach to the assets and succeed to the buyer. When purchasing a business, care must be taken so that undisclosed sales tax liabilities of the seller don’t inure to the buyer. Many states have rules that provide that certain taxes, such as sales tax, attach to the assets of the business being acquired. To protect the buyer from undisclosed liabilities, they should perform adequate due diligence prior to the purchase in order to identify and quantify any undisclosed sales tax exposure.
- Identifying nexus-creating activities of a selling company. During the due diligence process, a buyer should inquire as to the seller’s activities in all states. In addition to understanding where the seller had a physical footprint, a buyer should identify any potential nexus under the Wayfair standards. Buyers or their advisors ought to review the number of sales transactions into each state as well as the dollar volume of sales to customers in the state to identify whether nexus exists under these broader nexus standards.
- Look-back periods. While economic nexus under Wayfair may only go back to the date of a state’s adoption of those standards, a buyer will want to look at years prior to the Wayfair decision in order to identify if the seller had physical presence nexus in any state for which it was not compliant. Remember, if a business has not filed a sales tax return in a jurisdiction, the statute of limitations has not started to run. Accordingly, all prior years in which a return has not been filed in a particular state could be open for assessment.
- Resale certificates. Generally, sales of products or services to a person who will resell that product or service are not subject to sales tax since the purchaser is not the end user and will ultimately collect sales tax when the product or service is sold to the end user. In order for a seller to be compliant with a state’s resale exemption provisions, it must request resale certificates from all buyers that intend to claim a resale exemption. Since many businesses may have previously only collected resale certificates from customers in states where they had a physical presence, care must be taken to identify whether there are new states that as a result of Wayfair nexus would require the collection of resale certificates.
- Wayfair nexus exposure may affect the purchase price. The existence of prior sales tax exposure due to Wayfair nexus may be significant enough for a buyer to reduce the offering price. A thorough due diligence should identify possible nexus exposure, which a buyer may mitigate by including the appropriate indemnity clause in the agreement and/or requiring an escrow. However, many buyers may simply reduce their offer rather than rely on the terms of the agreement to address potential assessments.
- Costs of noncompliance, including interest and penalties. Prior-year sales tax exposure can be significant since the amounts are based on a percentage of gross sales. Additionally, past exposures would likely be subject to additional interest and penalties. Statutory interest rates can range upwards of 12%, and penalties can be as high as 25% or more. Since the sales tax exposure for noncompliance can go back many years, the added interest and penalties can make even a modest assessment quite significant.
- Consider the use of voluntary disclosure agreements. Once a buyer has identified potential past-year sales tax exposure, they should consider whether the filing of voluntary disclosure agreements (VDAs) in states with significant liabilities is beneficial. A VDA is typically an administrative process that provides favorable treatment concerning look-back periods (i.e., the number of years that a state will go back to assess) and penalty relief. A VDA may enable the buyer to settle any past noncompliance liabilities of the seller with certainty as to the number of years the state will be assessing.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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