Closing the sale

Last week we discussed reasons to structure the purchase of a business as an asset sale.

This week, we discuss successor liability and ways to effectively close the deal.

Learning after the fact that you are responsible for the tax obligations of the company you’ve acquired can be a very unpleasant and costly surprise. Tax law provides that a buyer (a purchaser that acquires “all or substantially all” of the assets of another business) is liable for the seller’s tax liability. This means the buyer must remit funds to cover the seller’s tax liability, if any exists. But there are protections in place to mitigate this liability.

While bulk-sale notification rules safeguard purchasers from this type of successor liability for sales tax purposes, they are time consuming and cumbersome. The notification rules are essentially an invitation for the state tax agency to audit the seller. Given that each state has its own unique process, a potential transaction could be delayed by months waiting on the tax-clearance certificate from the state tax agency.

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Once a clearance certificate has been granted, the state may require the buyer to place sufficient funds in escrow to cover any potential tax liability owed. For these business reasons, it is not uncommon for purchasers to opt out of the notification requirements and rely on the seller’s representation that it has complied with all of its sales tax obligations.

If the purchaser opts out of the notification requirements, then it should require that the seller perform a sales and use tax review prior to the acquisition to identify any areas of exposure and minimize successor-liability issues. The most common types of issues relate to failure to collect and remit sales and use tax and incorrect nexus or taxability determinations.

Once these issues are identified, the seller can take corrective measures to minimize any potential successor liability for the buyer. The most effective way to mitigate sales tax exposure is for the seller to enter into voluntary disclosure agreements with states where it has nexus but is not currently collecting or remitting sales tax. By having the seller enter into VDAs, the purchaser is assured that the seller is current with its sales and use tax obligations, thereby minimizing the risk of successor liability.

Additionally, when purchasers waive the notification requirement, they should also require the incorporation of indemnification provisions into the sales contract. Indemnification provisions may involve the escrowing of funds to cover any sales tax successor liability issues that arise.

If funds are not put into escrow the purchaser is forced to rely solely on the seller’s ability to pay at the time such liabilities are identified.

Sales tax liability can result in a significant unexpected cost relating to the sale or purchase of a business enterprise. Parties, especially purchasers, to a sale of a business should be aware of the sales and use tax ramifications of not only the transaction but also successor liability issues. •

Tarra Curran is a managing director in the Tax Group at CBIZ Tofias, which has offices nationwide, including in Providence and Boston. She can be reached at TCurran@cbiztofias.com.

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