Sales Tax Scaries 2: M&As

The Hidden Dangers of Sales Tax in Mergers and Acquisitions

Few business deals can ignite optimism like a merger/acquisition: new personnel, new challenges, exciting new opportunities and revenue streams. Too bad that past undisclosed sales tax obligations by one party can kill the whole deal with a scream. 

M&As were down last year, but the deals still totaled $1 billion. Historically, though, up to three-quarters of these deals tank – and surprise past-tax problems are frequently a reason.  

Sales tax risk might initially be considered just a marginal problem. 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. 

Unanticipated sales and use tax deficiencies can also mean creation of an escrow, and the founder of the target business, despite having created the true market value, ends up forfeiting money in escrow.  

How can you head off this nightmare? 

The Bare-Bones Examination: Due Diligence for Sales Tax Compliance

Due diligence will typically involve a complete review of the target company’s tax background, including all returns, audit history and accounting methods. Among key points: 

Understanding Nexus and Thresholds

Reviewing Product and Customer Taxability

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. 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?

Identifying and Mitigating Prior-Period Liabilities

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. These help a company self-report back taxes owed; in exchange, states generally waive penalties and limit the look-back period. 

After the Deal: Managing Post-M&A Sales Tax Compliance

Explore Sales Tax Mitigation Options

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) may be unnecessary in this case. 

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. 

Establishing an Ongoing Sales Tax Compliance Process

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. 

Avoiding M&A Nightmares Through Proactive Sales Tax Planning

Ignoring sales tax obligations could have a terrifying impact on an M&A in due diligence. Treat sales tax with the same reverence and attention paid to any other kind of tax – and its scary risk. 

Download our eBook, “How Sales Tax Impacts M&A" here.

Listen to our webinar “Mergers and Acquisitions Case Studies & Actual Negotiations” here.

If you’re looking to minimize the substantial risk of non-compliance, reach out to an expert, contact TaxConnex to learn how we partner our clients with an experienced and dedicated practitioner to ensure sales tax is taken care of.