Mergers and Acquisitions - For the Buyer
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat talk about what a business needs to be concerned about if they're going to be looking at buying a company.
Here’s a glimpse of what you’ll learn:
What sales tax liability issues should someone be on the lookout for when it comes to mergers and acquisitions?
What is successor liability?
Four big areas to look at: nexus, taxability, exemption certificates, use tax.
Have we seen anyone get into trouble because they didn’t know what to look out for?
How does a buyer go about doing their due diligence for mergers and acquisitions?
What is a tax clearance letter?
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More, your go to resource for all things state tax related. Now, here is your host, Michael Fleming.
Hi, Mike Fleming here, founder of Sales Tax and More. And today's co host of the Sales Tax and More podcast, where we talk about everyone's favorite topic, which is of course, sales tax. And, today we're going to, do the follow up. Last week, we, or last time we were on, we did merges and acquisitions from the point of view of the seller.
This week, we're going to look at it from the point of view of the buyer. But before we get started, let me
[00:01:00] introduce you to my co host, Ellie Moffat. Hey everyone, really great to be here. I'll just do a quick introduction for Sales Tax and More for those who may not have been listening to our podcast before.
We are a full service consulting and solutions firm, and we have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, and like our name states more.
So, if you have sales tax needs, if you're looking for a sales tax partner, please reach out. We'd love to hear from you and we would love to work with you. And that being said, Mike, let's just jump right in. As a buyer, What sales tax liability issues should someone be on the lookout for, when it comes to mergers and acquisitions?
Great question, Ellie. But before I answer that, let's, let's back up a little bit. We touched on
[00:02:00] this, in the sell side. Mergers and acquisitions podcast, but I want to go over it again today. And that's a concept called successor liability. And, when it comes to sales tax, the liabilities follow the assets.
And a lot of people say, well, I'm doing an asset purchase, so therefore, I don't have to worry about the liabilities because when you're doing an asset purchase, most of the, the liabilities are disregarded. You're only worried about the, the assets, but unfortunately, and a lot of smart people out there don't always get this sales tax liabilities are treated differently.
And they follow the assets, even in an asset purchase. So no matter how you structure a transaction, there's very little, you can do to get away from the, sellers, potential sales tax liabilities. That's what they call successor
[00:03:00] liability. And so many companies go out and purchase a company, not realizing, that they're purchasing any of the sales tax problems that this prior company had.
And that's why sales tax has become such a big part of many companies due diligence process, nowadays. And not all companies. But that should be one of the takeaways here. If you're out looking to buy companies, making sales tax part of your due diligence process is something that I think that you want to do now.
Let's get back to your question. I think you were asking me about what issues someone should be looking at. And, There, there's a couple of different issues. Number one, let's start with nexus. And nexus is simply a fancy word, meaning link or connection. And when someone has a link or connection with the state, they may have a responsibility to
[00:04:00] collect sales tax without this link or connection that we call nexus, you know, there's no, the state can't make you do anything.
So there's no responsibility to collect sales tax. So, companies should be figuring out what their own nexus footprint is and be collecting sales tax, when they're required. But if they're not, we can't assume that they're doing it. So as a purchaser of a company, I want to make sure that I understand wherever this company may have had, an obligation to collect sales tax and then figure out whether they were doing so or not.
So the first is some type of nexus review. And there's right now two primary types of nexus. One is economic nexus and, you know, simply crossing a certain level of transactions or revenue in a state can
[00:05:00] trigger that link or connection. And then there's physical nexus and physical nexus. Some of it's very obvious, you know, things like, Renting an office or owning an office building, having employees in a state, but some of it's not so obvious, like utilizing third parties to perform services on your behalf that also can create this link or connection we call nexus.
So as a purchaser, you want to make sure that you understand all of the activities that this, potential acquisition has been doing in the different states out there. You want to look at what their sales are. You want to look at what their transactions are in order to determine where they have nexus and where they had a potential responsibility to collect and remit taxes. So once we figure out, and maybe they're already registered everywhere, but we're worried not only about where they were
[00:06:00] registered in collecting tax, but where they were not registered where they should have been, in collecting tax. So two issues there.
Once we know where they should have been collecting tax, now we have to look at taxability. Is what they're selling taxable in those states? And if it is taxable, then we have to look at have they collected the right amount of tax? Has all of the tax that they collected been remitted? Have they filed returns as they were supposed to be?
If they're not taxable, maybe they didn't have a requirement, to be, collecting and remitting tax. But if they weren't taxable, there was a requirement. So, taxability is, is a big issue here because sometimes companies get some of what they're selling correct. They get the taxability right and they're doing, collecting the tax and remitting it and everything's right there.
[00:07:00] But this one product over here they thought was not taxable and it actually turns out taxable. So the 1st step is determining this nexus footprint. Where might there be a requirement to collect and remit taxes? The next step is figuring out what they sell, if what they sell is taxable. And by the way, how they sell it is often very important.
Also, for example, I may have an untaxable service but if I combine it with a taxable piece of tangible personal property in many states, the whole transaction becomes taxable. If I'm charging a single price, a lump sum price. So taxability big, big issue here. We want to make sure that they've got it right.
That the right amount of tax is being collected, that all of the tax that has been collected has been remitted, that all of the returns that needed
[00:08:00] to be filed have been filed. So taxability is, is, is the second most important issue. Taxability, usually a little bit harder to understand than nexus.
So that's why we say nexus is the first step. If you're only have nexus in 12 states, why look at taxability in 50 states? Just look at the taxability in those 12 states where there may have been a potential to do something. So those are the two big issues there. We've got some minor issues, like exemption certificates.
This is the biggest problem when it comes to audits. You know, sometimes, the customers of your potential acquisition will have said, well, I'm exempt. Well, an exempt sale is only exempt if it's properly documented. If you don't properly document it, states don't usually recognize it as a taxable sale, excuse me, as
[00:09:00] an exempt sale. They're going to treat it as a taxable sale. So you want to make sure that all of the exemption certificates that should have been collected have been collected. And if they, they're not, then you need to request the seller to go back and perfect all of those certificates. I mean, you don't want to have to, maybe once you make the acquisition, they decide they don't want to be a customer anymore.
Well, you're still on the hook if you ever get audited for the transactions that took place when, prior to the acquisition. So you want to make sure exemption certificates and exemption certificates have an outsized impact on audits because audits are done on a sample basis. So it's not just the tax that would have been on a 1 invoice that you don't have a certificate for an invalid certificate.
It's what that invoice represents is, in the sample. What's the error percentage? Because you're gonna have to extrapolate that out over the population. And
[00:10:00] because of that they always have an outsized impact on audits. So we want to make sure that not only do we know where we should have been collecting tax, not only do we know what's taxable or not, and that all of the tax has been properly handled, but we've got to watch those exemption certificates also, because we know that's one of the areas.
That the states are going to concentrate on if you ever get audited, and it leads to very large assessments, or it's the number one cause for large assessments in companies that have to, collect sales tax. Another issue, and this ties into, taxability, is use tax. You know, just because someone doesn't charge you tax does not mean it's a tax free purchase.
It could be. Maybe you're buying something for resale. Then you don't have to worry about the tax on it, but if it was a taxable transaction, you're supposed to self assess and remit that use tax
[00:11:00] directly to the state. So you want to be looking at, you know, this potential acquisition. You want to be looking at their purchases.
Did they pay sales tax? If they didn't pay sales tax and it was a taxable transaction, did they self assess and remit a use tax? Big areas of, problems, large software purchases, you know, that usually trips people up, whenever they're doing renovations, wherever they're making a lot of purchases, that could be potential use tax issues.
So, we want to make sure that you're not getting, yourself, any of the problems from their potential use tax issues, because that's the number two reasons for large assessments is people don't understand that when they're not charged tax that they may have a potential requirement to self assess and remit that tax to the state themselves.
So those are really the four big areas there. I mean, we can talk
[00:12:00] about, you know, are they registered with the secretary of state? Are they paying the corporate income taxes, that they're required to. But the sales tax is by far the biggest issue. In my opinion, when it comes to, you know, success or liability.
And these are the four biggest issues when it comes to doing your due diligence on a potential purchase. So did I sort of answer that question there, Ellie? You did, and I was going to kind of reemphasize the same point that you just said, I was going to say, those are some big bullet points to take note of here.
So, but Mike, yeah. You know, every, I'm sorry, I didn't mean to interrupt you. Every situation is going to be a little bit different. That's where you want to start with those four big areas there. But if you want some more specific guidance as it relates to a specific industry or specific fact pattern, reach out, we do a lot of due diligence work and we
[00:13:00] can help you, perhaps avoid some of these potential pitfalls we've seen other companies make. And you know, that's actually a really good, really good transition into my next question here, Mike. So have we seen anyone get into trouble because they didn't know what to look out for? Yeah, absolutely. And they're always surprised.
I mean, sometimes, you know, a state will reach out and, you know, someone will reach out to us and said, Hey, we did an asset purchase. We're not responsible for that. And, you know, their accountant or their attorney thought they didn't think this through. They didn't understand, that, sales tax liabilities follow the assets, even in an asset purchase.
And now. Because they didn't do the due diligence, they've got all of these problems and sometimes, you know, if you knew about these problems up front, you may not have gone through with the acquisition. This may turn a profitable transaction or acquisition
[00:14:00] into a negative. Because sales tax problems can be huge. I mean, especially if they've been going on for six, seven, eight years. You've got the back tax to worry about the penalty and interest, you know, back tax, you know, can range anywhere from six to 10 percent or more in minor instances. And penalty and interest can quickly add up to 50 percent or more.
So this can be a huge, huge issue and you don't want to be, the one holding the bag. When you thought you were making a good acquisition. So we see it come across in all different, different ways. You know, sometimes, the seller misrepresented sometimes, the seller didn't understand and they answered the questions to the best of their ability, but, states don't care about that.
States care about, you know, the facts, just the facts, ma'am. And the, the fact
[00:15:00] is that we see all sorts of companies, whether they were stock sales or asset sales, all of a sudden inheriting all of this, mess and, we're often tasked with helping dig out of it. So we may do voluntary disclosure agreements.
We, may, usually a voluntary disclosure agreement can only be done if the state doesn't know about you. So if it's a state that has reached out, it may be too late in that state, unless it's a state like Michigan that still allows a VDA or perhaps Florida, But what that does do is alert you to other states because if one state comes after you, then they're probably going to be other states down the road because states do talk to each other.
So you want to make sure once you discover that there is an issue. You want to be proactive because you have a lot more option, options when you're being
[00:16:00] proactive than when you're being reactive. So yeah, I mean, if we have all day, I could give you example after example, after example of people who have come to us, not realizing they were buying a bag of trouble.
Mike, we kind of, we've touched on this briefly a couple of times now, but how does a buyer go about doing their due diligence in the sales tax arena for, for merger acquisition? Well, we sort of touched on this earlier. You know, a nexus review. That is something that you, you want to start with. If this is something that you're not used to doing, then you would go to a third party like us, or, you would make sure whoever's, taking you through the due diligence process, because I'm sure that you're doing some type of due diligence before you make this acquisition, and they may already have the expertise to do it on their own, or you may point them in someone like ours
[00:17:00] direction to be the subject matter expert to handle this very specific piece of the due diligence process.
So, there are tools out there. You know, like, on our website, we have a, economic nexus chart. Someone can take that chart and go out and figure it out on their own. If a company has a nexus, but generally you got a lot of things going on and you don't want to make a mistake when you're doing this.
So although there are a lot of tools out there that you can use to help get you through this, probably better to see the aid of someone who does this on a regular basis. All right. Anything else you want to add in here before we wrap up? Mike? Yeah, the the time to really do this. Is when you decide that you want to make a purchase.
I mean, you don't want to be cleaning this up after the purchase
[00:18:00] closes, because as we mentioned, you want to be proactive. So, a lot of the options are off the table once the transaction closes. If someone's registered and collecting in states, then you can ask for a tax clearance letter and a tax clearance letter is when the seller of a company goes to a state and says, Hey, I'm going to be selling my company and I need a letter from you stating that everything's good, that I don't have any, outstanding liabilities.
And if you get that tax clearance letter, And it's, it's clean, then you're off the hook. A tax clearance letter will prevent the, the successor's liability. The liabilities will not transfer to you. Now, if there is a problem, and the state comes back and says, well, there, yeah, this person owes $5, 000.
Then you need to, out of the proceeds of the transaction, you need to pay the state
[00:19:00] directly. The seller cannot get those proceeds. So tax clearance letters. That's a big part of this. If they're not registered, you may want to tell them to go out and go through the VDA process or whatever process they're going to go through, to clean this up prior to the transaction closing.
Now, sometimes you may have short time frames and some VDAs take forever. Some states right now are backed up. A lot of people wanting VDAs in some states like Virginia. There's one person doing the VDAs, so it may take a year or more to from the start of that VDA to the completion of that VDA.
What we've seen a number of companies do is set up escrow accounts and they hold back a certain percentage of the sale to cover any potential sales tax liabilities. And, that money is released to the seller, either after
[00:20:00] all of the sales tax liabilities have been cleared up or potential liability has been cleared up, or we have also seen them set up where.
As a certain percentage of the potential liabilities cleared up, a certain percentage of the escrow fund is released, but you got to protect yourself somehow. Otherwise you're on the hook. I mean, if you give all the money to the seller, that seller may disappear or that seller may spend the money or, that seller may have owed IRS taxes or whatever else.
And that money is gone. So you want to protect yourself somehow. And, indemnification agreements are also good. If anything shows up for a certain period of time, then the seller is responsible for that. Usually some type of indemnification agreement by itself. Seller may not have the money. So, you utilize the indemnification agreement
[00:21:00] along with a, escrow account,
so those are just some of the things you need to do. First you got to do your due diligence. You got to know if there are actually any problems you want to do it before the transaction closes and you want to write into the actual agreements. You know, indemnification escrow, or you want the seller to get this all cleaned up before the transaction actually closes. You've got to make sure you're doing your due diligence and you got to ask about it. When I did the, the due diligence for, the sell side, my recommendation there was you got to answer, the purchaser or potential purchaser accurately. You can't lie. If they ask you a question, you got to answer truthfully, but if they're not asking about sales tax, you know, maybe this is a moral question or an ethical question, Do not, volunteer, you
[00:22:00] know, the old, saying, let the buyer beware.
If you're not doing your due diligence, do not expect the seller to tell you. They may not know number one, that's how this happens in the majority of the cases, but sometimes right before the sales, someone will tell them, Hey, have you done this? And they say no. And all of a sudden they're panicking.
And if you're not asking, they're not telling. So very, very important that you make. Sales tax part of your due diligence process. All right. Well, if you have sales tax needs, if you need help with your due diligence. We offer many solutions, many services.
We'd love to hear from you. We'd love to help you. If you've enjoyed listening to our podcast, please like, and subscribe. It helps us, know that it's reaching people and helps us keep going and producing more helpful content for you guys to, to listen to. You can reach out to me directly if you are
[00:23:00] interested in our services. My email address is e Moffat, E-M-O-F-F-A-T at sales tax and more.com. Our website is sales tax and more.com. And, in addition to the services we offer, in addition to this podcast, we have a entire series of free webinars of free educational resources on our website, along with paid ones as well in our salt vault that go a little bit deeper.
So again, thank you so much for listening. We love having you here. Thank you everyone. We appreciate you spending your time with us today and we hope to see you on the next episode of the Sales Tax and More podcast. Bye bye.