As part of the financial terms of any potential transaction, you’re likely looking at the ratio of current assets to current liabilities, revenue and net income growth, operating cash flow, market opportunity, etc. But what about sales tax?
Sales tax risk might be considered immaterial, but when you consider up to 10% of a business’s overall revenue could be exposed, compounded over a period of multiple years, including penalties and interest for non-compliance; sales tax risk can be quite significant. If sales tax risk is identified during the diligence phase, it will be a painful experience. You’re either looking at an escrow item, or worse, tanking the entire deal.
Here are the 5 steps to determining your sales tax risk now so you don’t have to experience the pain during the diligence phase of an expected exit:Determine Where Sales Tax Nexus Exists
Nexus is the connection between a person or entity and a taxing jurisdiction. Sales tax nexus is the basis for all sales tax decisions because without sales tax nexus a business has no further obligation to a state.
Have someone perform a thorough review of your business to understand where you may have enacted physical or economic nexus. A thorough review of all sales activities including transaction volumes should be looked at by each business. Not every business will be willing to pay the fees associated with a formal economic nexus review. If nothing else, all businesses should review the last twelve months of sales activities and see if any states have more than $100,000 in sales. While this is not a 100% accurate method, it’s a first guide that would suggest the need for a deeper dive into that specific state to determine if the economic nexus thresholds have been crossed.Review Taxability of Products and Services
Estimate the Amount of Sales Tax Exposure
Once nexus is determined to exist, the next step is to determine whether a business’s products or services are subject to sales and use tax. The sales and use tax is generally imposed on the sale or use of tangible personal property and some services. These taxes are intended to be passed on via the invoice to the end user/consumer. In most states, communications services are also subject to sales tax.
There are two primary reasons to estimate the prior period exposure:
The data will assist in determining a mitigation strategy; and
If you are publicly traded, you are required to disclose the exposure on the financial statements if it meets the reportable criteria/thresholds.
To gain an estimate of your liability/risk, you can use our calculator tool, but to get the most accurate data it is best to talk to a sales tax expert.Evaluate Mitigation Options
If prior period liabilities are identified prior to acquisition, a business should evaluate mitigation options. Unfortunately, if the liabilities are identified during diligence, the options are often limited – consisting of either escrowing funds or entering voluntary disclosure agreements.Establishing a Tax Compliance Filing Process
Once a business has determined there is 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. This can be a daunting process with many steps. Many businesses look to outsource the compliance process to remove the stress and liability off of them.
If you are a business, or are looking to purchase a business, with customers in multiple states, the scope and risk grows in accordance with the number of states and the sales tax complexities in those states. Ignoring your sales tax obligations could have a massive impact and cause a deal to not go through. If you are looking to purchase a business, make sure you are aware of where sales tax exposure exists and have steps in place to remediate the prior period risk and also address sales tax compliance prospectively.
To learn more about these 5 steps and to better understand the impacts sales tax could have on your M&A, download our eBook. Click below to download.