Sales Tax Horror Stories: M&A

The past two years have seen nearly 46,000 M&As in the United States. It's clear that nothing can boost a business like the right merger or acquisition.

Yet many of these deals tank: as many as 70% to 90%, Harvard Business School has reported. And one thing that can pound a stake through the heart of a promising M&A is unearthing past tax liability during due diligence.

Enter past-due sales tax, a sometimes-overlooked and haunting liability that might not get the attention of, say, overdue income or property tax, until it’s too late.

Yes, at first glance sales tax risk might be considered just a marginal risk. But when you think of how up to 10% of a business’s overall revenue could be exposed and compounded over a period of multiple years (including penalties and interest for non-compliance), sales tax risk can put a stake right through the heart of an otherwise promising deal.

(And it can be much easier to spot a sales tax problem with a public company because of the added scrutiny of public reporting and independent auditing. Smaller, private companies are less scrutinized.)

Unanticipated sales and use tax deficiencies can mean creation of an escrow – and don’t look for new owners to work much to minimize the expense and liabilities that the escrow was set up to protect against. The founder of the business, despite having created the true market value, ends up forfeiting the money in escrow. 

Scary and unfair, yes. And avoidable.

Step by step

Due diligence will typically involve a trull review of the target company’s tax background, including all returns, audit history and accounting method. Sales tax should get extra attention if the two companies are in different industries.

A few simple additional steps can head off sales tax risk in an M&A:

Determine sales tax nexus. Nexus is the connection between a person or entity and a taxing jurisdiction. A thorough review of all sales activities, including transaction volumes, should be looked. All businesses should review the last 12 months’ sales activity and see if any individual states saw more than $100,000 in sales – a typical nexus threshold nationwide.

Review taxability and estimate exposure. Once nexus is established in a state, determine whether a business’s products or services are subject to sales and use tax there. Requirements can vary widely. 

There are also two big reasons to estimate the prior-period exposure: The data can help determine a strategy to mitigate the liability; and, if a company is publicly traded, it must required to disclose the exposure on the financial statements if it meets the reportable criteria/thresholds.

Evaluate mitigation options. If prior-period liabilities are identified well before the deal, everybody has a better chance to explore mitigation. If the liabilities are identified during diligence, options are often limited – consisting of either escrowing funds or entering voluntary disclosure agreements.  

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 – a daunting process with many steps. Many businesses look to outsource the compliance process to remove the stress and the legal liability.

If you look to purchase or merge with a business or your company wants to attract suitors, heed a big rule of M&A: Learn about any prior sales tax exposure ASAP.

(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’re looking to minimize the substantial risk of noncompliance, reach out to an expert. Consider working with TaxConnex. Contact us to learn how we partner our clients with an experienced and dedicated practitioner to ensure sales tax is taken care of.