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M&A Sales Tax Missteps: Strategies for Compliance and Success

Whether on the buy-side or the sell-side, the weeks leading up to an acquisition can be riddled with obstacles. Part of the process is identifying potential risks, and one of the biggest is sales tax. When you consider up to 10% of a business’s overall revenue could be exposed – compounded by penalties and interest for noncompliance – sales tax issues are quite a significant risk.

Jun 11, 2024, 23:25 PM

Jeff MeigsBy Jeffrey Meigs


Whether you are on the buy-side or the sell-side, the weeks and months leading up to an acquisition can be intense and riddled with obstacles before a deal can be closed. Some hurdles can be significant, including cultural fit, management structure, business systems integration, and the financial terms of the deal.

As part of the financial terms, important factors include the ratio of current assets to current liabilities, revenue and net income growth, operating cash flow, market opportunity, among others. Another part of the process is identifying potential risks in the business. One of the biggest is sales tax. If you have historical noncompliance when it comes to sales tax obligations, there is a high likelihood that it will be exposed during due diligence.

Sales tax risk might be considered immaterial by some, 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 noncompliance – sales tax risk is actually quite significant.

Examining tax documents with a magnifying glassWhen sales tax risk is identified during diligence, decisions will need to be made. At best, it will need to be addressed as an escrow item; at worst, it could tank the entire deal.

If you are considering acquiring another business or selling your own business, it is important that you understand your sales tax exposure and determine your best mitigation options in advance of due diligence.

The first step is to understand where you have established a sales tax obligation. Even if you believe you have a compliance process in place, an evaluation of your nexus footprint and product taxability state by state, at least annually, is recommended. As your business grows, as new products/services are added, and when you acquire new entities or develop new sales channels, sales tax obligations are likely to grow.

Nexus is where an evaluation should begin. Sales tax nexus can be determined by either a physical or economic presence. It is an either/or situation; both are not needed. It is important to evaluate whether you’ve reached the sales tax nexus standard in every state in which you have sales or have established a physical presence due to traveling sales reps, stored inventory, or resident employees.

If you do not have nexus in a state or jurisdiction, there is no need to evaluate taxability. However, once nexus is determined to exist for the company, your next step is to understand if your products/services are taxable within that state or taxing jurisdiction. It is important to remember that taxability isn’t the same across all states or even local jurisdictions. The more products/services you offer and the more complex those products/services are (i.e., bundled transactions and technology solutions), the more critical it becomes to evaluate your product/service taxability in each state where nexus exists.

After the nexus determination and the taxability determination, an analysis of prior-period exposure should be performed and an estimate of exposure (tax, penalty, and interest) should be calculated. Generally, if a company is not registered in a state for sales tax purposes, there is no statute of limitations. This means states have the authority to assess the sales or use tax as far back in time as applicable. However, in most states, the administrative policy is to limit the “look-back” to only seven years when determining prior-period liability for unregistered businesses.

If prior-period liabilities are identified prior to an acquisition, evaluate mitigation options and prospective compliance plans. If sales tax was collected but not remitted, the taxes must be paid to the state as soon as possible.

Unfortunately, if the liabilities are identified during diligence, the options are often limited, consisting of either escrowing funds or entering voluntary disclosure agreements.

Here are a few mitigation options to consider:

  • Refund tax to customers – This option should only be considered when sales tax has been collected and not remitted to the taxing authorities and the business was not required to charge sales tax on the transaction. Collecting sales and transactions tax and not remitting to the jurisdiction could be considered a criminal offense and subject the corporate officers to criminal prosecution.
  • Prospective registration and compliance – Depending on the materiality of the tax exposure, prospective registration and compliance may be the most logical business decision. This assumes no sales tax has been collected. It is important to understand that this option doesn’t mitigate the prior period exposure, but at least puts the business on the appropriate compliance path. An accrual of the prior period exposure for financial statement purposes might be appropriate in conjunction with this approach. If the sales tax is material or has been collected but is a recent liability, it might be more logical to pay said tax exposure on the first return under this option. Note that these taxes would still be subject to penalties and interest under audit.
  • Voluntary disclosure agreement (VDA) – Almost all states have a formal VDA program that allows nonregistered taxpayers to disclose a sales and use tax liability in exchange for penalty relief and a limited look-back. It was stated earlier that most states do not look back further than seven years for an unregistered taxpayer. Most states’ VDA programs will prescribe either a three- or four-year look-back period. Where a taxpayer has collected tax and failed to register to file and remit said tax, the limited look-back period doesn’t apply, and all tax collected must be remitted.
  • Amnesty – On occasion, a state will offer an amnesty program. These programs are similar to a VDA except there usually isn’t a look-back period. Another primary difference between amnesty and a VDA is that registered taxpayers can participate in amnesty. The purpose of amnesty is primarily to generate revenue for the state while accelerating collections of outstanding liabilities already assessed against taxpayers. Amnesty programs have a short life span – sometimes three months – and aren’t common.

Entering into a merger or acquisition is a big decision and a lot of information is required to move forward successfully. By starting an analysis of your sales tax responsibilities now, you are afforded the crucial time needed to execute a mitigation and compliance plan – potentially reducing or even eliminating sales tax from scrutiny under due diligence. Ultimately, sales tax is the responsibility of the end-user/consumer. However, the vendor is commonly held liable for sales tax as a collection agent for the state. The sooner you are complaint, the more effectively you pass the sales tax burden on to your customer, where it belongs – and the less costly it is to you in an acquisition or jurisdictional audit.


Jeffrey Meigs, partner, consulting practice leader, at TaxConnex in Alpharetta, Ga. He can be reached at www.taxconnex.com/contact-us.


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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.



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Disclaimer

Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of PICPA officers or members. The information contained in herein does not constitute accounting, legal, or professional advice. For professional advice, please engage or consult a qualified professional.

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