Why are taxes so important to the sale of a closely-held business? Economics. Any deal, whether from the perspective of the seller or of the buyer, is about economics, and few items will impact the economics of a deal more immediately and certainly than taxes. The deal involves the receipt and transfer of value, with each party striving to maximize its economic return on the deal. Simply put, the more that a party to the deal pays in taxes as a result of the deal structure, the lower is the party’s economic return.
Depending upon the deal structure and the assets of the target business, several kinds of taxes may have to be paid and several kinds of returns may have to be filed, thereby making the taxing authorities de facto parties to the deal: they too will have an opportunity to review the deal structure, and its tax consequences, after the relevant tax returns have been filed.
When many practitioners consider the taxes arising out of the purchase and sale of a business, they tend to focus upon federal income taxes. Often overlooked are state and local transfer taxes, including sales taxes. These transfer taxes, however, can have a significant impact upon the economics of the deal.
Deal Structures & Questions Re Transfer Taxes
Before delving into sales tax considerations in M&A transactions, it would be helpful to review the basic deal structures. In an asset sale, the selling corporation sells its business to the buyer. In a stock sale, the shareholders of the target corporation sell their shares of stock in the target to the buyer.
In the context of these basic transaction structures, two questions must be addressed:
(1) Will the asset or stock sale trigger the imposition of sales tax?
(2) Will the buyer become directly or indirectly liable for the seller’s unpaid transfer tax liabilities as a result of the transaction?
Sales Tax Basics
Except as specifically exempted or excluded, the sales tax is imposed on the receipt of consideration from every “retail sale” of tangible personal property (TPP). The consideration may take many forms, including money, notes, or other property (including equity in the buyer), and includes the assumption of liabilities. In general, a sale “at retail” means any sale of TPP to any person for any purpose. It is essentially a transaction tax, with the liability for the tax occurring at the time of the transaction.
The time or method of payment of the consideration is immaterial. When a sale is made for which payment is not received at the time of delivery, the sale must still be reported on the sales tax return covering the period in which the sale is made, and the full amount of the tax must be remitted with the return. There is no installment reporting.
The tax is a “consumer tax” in that the person required to collect the tax—the seller, who collects it as trustee for an on account of the state—must collect it from the buyer when collecting the sales price for the transaction to which the tax applies. This includes one who is selling a business – there is no “casual sale” exception.
Certain transfers of property that occur as part of a corporate or partnership transaction are not treated as retail sales. For example, there is a “merger exemption” under which the transfer of property to a corporation solely in consideration for the issuance of its stock, pursuant to a statutory merger, is not treated as a retail sale and, so, is not taxable.
However, the exemption does not apply to the extent that the consideration received in the merger consists of cash or other property, including the assumption of liabilities other than those that are secured by the transferred assets.
Moreover, in order for the merger exemption to apply, the stock issued in consideration for the transfer of the TPP to the acquiring corporation must be the stock of the acquiring corporation receiving the property. A transaction in which the stock of a parent corporation is issued does not qualify for the exclusion.
Note that the availability of the merger exemption is not linked to its qualification as a tax free reorganization for federal income tax purposes under IRC Sec. 368.
Tangible Personal Property
TPP does not include real property or intangible personal property. Thus, where shareholders sell all the stock of a corporation, no sales tax is owed since no TPP was transferred. In the case of an asset sale, the transfer of accounts receivable, investments in securities, shares of subsidiaries, and goodwill/going concern value are all excluded from the reach of the sales tax since they represent transfers of intangible assets.
“Assuming” Target’s Liabilities
It should be noted, however, that a corporate merger or acquisition of stock, which is not itself subject to sales tax, may not be free of sales tax consequences.
In the case of a merger, while the transfer itself may not be taxable, the buyer is “assuming” the seller’s pre-existing sales tax liabilities by operation of law, and the buyer’s other assets will now be exposed to the target’s sales tax liabilities.
In the case of a stock acquisition, the buyer takes the target corporation as is, including any pre-existing sales tax liabilities for which the corporation is liable; those liabilities continue to reside within that corporation (unless the corporation is subsequently liquidated into the buyer).
Exemptions in an Otherwise Taxable Deal
In addition to certain excluded transactions, the sales tax provides exemptions for the sale of certain types of TPP. These exemptions are strictly construed, and the burden of proving non-taxability is on the person claiming the exemption.
The two most commonly encountered exemptions in the sale of a business are the “resale” and “exempt use” exemptions.
An exemption is allowed for receipts from the sale of machinery or equipment used or consumed directly and predominantly in the production for sale of TPP.
In addition, an exemption is allowed for the sale of property for resale of the property as such (inventory) or when the property is purchased for resale as a physical component part of other TPP.
It bears repeating that every person required to collect the tax acts as a trustee for and on account of the State with respect to the taxes collected by such person. It also bears repeating that all sales of property are deemed taxable until the contrary is established. The burden of proving that a sale is not taxable is upon the seller and the buyer. Thus, notwithstanding that a transaction may not be taxable, the parties must pay careful attention to the documentation as to any exemptions claimed.
A seller who in good faith accepts from a buyer a timely and properly completed exemption certificate evidencing exemption from the tax is relieved from liability for failure to collect the sales tax with respect to that transaction. However, reasonable ordinary due care should be exercised. A seller may not have knowledge that the exemption certificate is false.
Although the certificate is considered timely if it is received within ninety days of delivery of the property, such an extended period is usually impractical in the context of a sale of a business. It behooves both parties to make the production of any such certificate one of the items to be delivered at the closing.
In all cases, the parties to the sale transaction must maintain records sufficient to verify all sales tax-related aspects of the transaction.
In the case of someone who sells his business and ceases operations, a final return must be filed within twenty days after the occurrence of such event. The return will cover the period from the first day of the actual tax period in which the event occurred to the final day of business.
This final return must be marked as such.
It must be accompanied with payment of all taxes due through the final day of business, including any tax collected from the buyer on the sale of the business.
…Stay tuned for Part II, Bulk Sales!