A couple of weeks ago we took a look at what controllers and CFOs need to think about prior to their company being acquired. But what if you are looking to acquire another business?

How Sales Tax Affects Mergers & Acquisitions

 

Because sales tax is a gross tax, it cannot be offset by net operating losses like income tax can. This is why larger acquirers begin the process by analyzing the target company’s potential outstanding tax liabilities they would be taking on. If the business they are looking to acquire has not thought through the ramifications of multi-state sales tax issues, it can either completely derail the deal or negatively impact the final purchase price.

How Can Your Business Prepare?

 

Make sure that before you acquire a business, you know exactly what you are purchasing by doing due diligence before the deal. The results you find may affect the agreement you reach.

For example, we had a client in a medical device field. They sold a very interesting product to small–medium sized doctor’s offices across the country; they were advised by an accounting professional that they only needed to worry about collecting sales tax in their home state of California and one other state where they had an employee residing. However, the company created nexus in many states by virtue of traveling salespeople entering the state and providing demonstrations, training and ultimately installation of the product. It turned out they had significant outstanding (and understated) liabilities of more than $1 million.

As they were being courted by a much larger company to engage in a mergers and acquisitions deal, the acquirer informed them that, while they would move forward with the deal, they would require a significant hold-back of funds for unpaid sales tax liability. While we were able to assist the target company in significantly reducing the arbitrary holdback by performing a more detailed taxability review and communication with their customers about self-assessed use tax, the process took some time and energy that that company could ill afford. We ultimately reduced the holdback amount by more than half, but it is still an example of where much of this pain could have been alleviated if the company had done its due diligence six months prior to putting itself on the market.

Even though our client was the target company in this scenario, this example shows how it paid off for the acquiring business to do due diligence. Had they not thought to analyze where our client had nexus and exposure, they may not have negotiated and booked the holdback amount, and it could have cost them significantly moving forward.

Next Steps for Companies Looking to Acquire

 

Exercise caution before entering into a deal.

Perform a nexus study on any potential company you may acquire, or ask if they have done one.

Here are some questions to consider:

• Does the company engage in multistate activities?
• Where are they currently filing?
• How long have they been filing?
• Have they recently (within the last two years) conducted a nexus review or taxability study?
• Has it been well documented in their files?

If the company you are considering for acquisition has done a nexus study in the last two years, ask to see the documentation.

If they have not done a nexus study in the last two years, perform your own due diligence and analysis. You do not want to take on unexpected exposure liability. Even a high level analysis is important.

Mergers and acquisitions are complicated. We recommend people of varying backgrounds be involved to make sure everything is done correctly:

• Federal tax experts
• Multi-state tax experts
• Sometimes international tax experts

In a mergers and acquisitions transaction, federal tax practitioners are often brought to the table to make certain that the transaction is accounted for correctly from a federal income tax perspective. Is the deal structured as a stock deal? Or an asset deal? Are there elections that can be made with respect to either? It is important to note that while most states will follow the federal treatment, it is not always the case. And, again, the sales tax ramifications may be different than the income tax ramifications.

As you consider entering into a merger or acquisition, make sure you learn everything you need to know up front so you can make a sound decision.