The importance of sales tax due diligence in M&A has skyrocketed since the Supreme Court’s Wayfair decision.
Introduction: The Impact Of The Wayfair Decision
We all know how the Supreme Court’s Wayfair decision completely changed the sales tax landscape. We went from a physical presence-based nexus standard to one that not only includes those same tenets but also economic-based standards. It’s easier than it ever has been to trigger sales tax nexus in a state.
Sales Tax Nexus: Easier To Trigger
Because of how easy it is now to trigger sales tax nexus, sales tax exposure analysis has skyrocketed. It is now at the top of the due diligence checklist when it comes to M&A activity. Unfortunately, it wasn’t always that way. Even today, it’s often done by professionals who don’t understand the multiple nuances within our vastly expanded sales tax world.
The Importance Of Experienced Sales and Use Tax Professionals
Why Expertise Matters In Sales Tax Due Diligence
Here, I want to highlight why it’s important to have an experienced sales and use tax professional involved in the tax due diligence related to the sale/acquisition of a business. But first, let’s take a look at how things used to be.
Pre-Wayfair Due Diligence
Sales Tax In M&A: An Afterthought
I spent a significant amount of my career with a Big Four public accounting firm (1998-2016). During that time, sales tax issues were often viewed as an afterthought – in general but especially in the M&A space. Occasionally, I was asked to help one of the M&A teams with the sales tax portion of the due diligence.
Challenges Of Late Involvement
When that did occur, it was generally less than a week or two until the transaction close date. This meant that I didn’t have nearly enough time to request and receive the needed documentation to do a thorough review. There were lots of assumptions and caveats and it just felt like a basic, check-the-box kind of task to say it had been done.
Lack Of Dedicated Sales Tax Professionals
Other times, a sales tax professional was never sought out by the M&A team, whether it was me or anyone for that matter. The tax due diligence process was dominated by income tax considerations, at the federal and international levels. In these situations, any sales and use tax analysis that was done was performed by income tax professionals. While they were tax experts, they were not sales tax experts. Not by any stretch.
Sales Tax Due Diligence Today
Increased Importance Of Sales Taxes
It should come as no surprise that the importance of sales taxes in the post-Wayfair environment has increased exponentially. As I mentioned earlier, it is so much easier to trigger sales tax nexus today. With a few exceptions, selling $100,000 of gross sales is enough to obtain a collection and filing obligation.
Challenges In Current Analysis Practices
As a result, there is significantly more importance placed on the sales tax portion of the tax due diligence compared to how it was before. However, that still doesn’t mean the analysis is thorough or being done correctly. I’m still seeing the high-level, broad-stroke analysis being done with tons of assumptions and caveats.
Proactive Seller Analysis
The Case For Seller’s Own Analysis
What sellers should be doing is hiring experienced sales and use tax experts to do their analysis of their sales and use tax exposures instead of relying on the buyer’s M&A team.
Early Analysis Benefits
I’d argue that sellers should consider doing that analysis as soon as preliminary sale conversations begin so that the seller knows what exposures are out there from the very beginning and can potentially rebut any exaggerated exposure assertions from the buyer.
Why Hire Your Own Expert For Sales Tax Due Diligence?
But you might be asking, “Why would I hire my own sales tax expert when the buyer is responsible for the due diligence and the related fees that go with that?” Let me explain using a recent real-life example (or two).
Sales Tax Due Diligence Case Study #1
Client Scenario: Service-Based Company Sale
I had a client who was referred to me and sold their fast-growing services-based company to a private equity firm. As part of the due diligence, a top 10 public accounting firm had performed the sales tax portion of the due diligence on behalf of the buyer and determined that the company had significant (seven figures) sales tax exposure in a handful of states.
Misclassification Of Services
The accounting firm concluded that the company sold SaaS, which is taxable in several states, and therefore had significant sales tax exposure in those states because the company had never collected any sales taxes. As such, the buyer had escrowed that amount from the sales price and had requested the company remediate those exposures before it would release any amounts.
Impact On Seller
The CEO/founder of the seller was directly impacted by this – she started the company and it was her money that the buyer was holding back.
Resolution And Importance Of Expertise
Clarus Partners was engaged by the seller to come in and do our analysis of (1) the company’s nexus profile and, more importantly in this case, (2) the taxability of what the company actually sold in the nexus states. We determined that nothing the company sold was taxable in any of the states in which it had triggered nexus. In other words, there was no sales tax exposure because their services could not be considered SaaS.
Outcome: Seller’s Favor
We then prepared a technical memo. This explained the analysis and conclusions, provided to the private equity firm and the top 10 accounting firm. While it took a while, they both ultimately agreed with our process and conclusions. The seller got the rest of her money from the agreed-upon sales price. The takeaway here is that just because a big public accounting firm comes in and says there’s exposure doesn’t make it so. Just like with big medical decisions, you might want a second opinion.
Sales Tax Due Diligence Case Study #2
Client Scenario: E-Commerce Retailer
I have a more recent client in a similar situation. This involved an e-commerce retailer that was referred to me by their CPA firm. The e-commerce retailer disagreed with the exposure the Big Four firm had calculated and included in the due diligence report.
Questionable Exposure Calculation
I was provided a copy of the exposure analysis and it was chock full of assumptions and caveats. The Big Four firm, which was hired by the buyer, estimated between $1M and $1.2M of sales tax exposure.
Deep Dive Analysis
Clarus Partners was hired to review the nexus footprint and determine when nexus was created. Then from there, the sales tax exposure on their sales. Because of Wayfair, this company had nexus everywhere. However, exposure is calculated from the date they were required to be registered for sales tax until either (1) the current date or (2) whenever the company did register for sales tax, whichever comes first.
Outcome: Reduced Exposure
Doing the deep dive like we did, we determined that on the high end, their actual exposure is half of what the Big Four firm calculated, at most. Additionally, we might have other ways to further reduce that exposure, which frees up more of the escrowed sales price.
Conclusion: The Need for Dedicated Experts For Sales Tax Due Diligence
Proactive Planning for Sellers
As a full-service indirect tax professional services firm, we regularly advise our clients on numerous issues when it comes to selling their business and what they should be thinking about now even though it may be five years away.
Importance Of Sales Tax Expertise in M&A
Just because a buyer brings in a heavyweight public accounting firm as its due diligence firm does not mean that you, as the seller, should feel comfortable that they know what they’re doing. They’re working for the buyer, so any exposure amounts they come up with that they can support – whether accurate or not – will negatively impact cash at closing.
Final Recommendation
At minimum, make sure the buyer team has dedicated sales tax experts conducting that portion of the due diligence. Alternatively, give Clarus Partners a call and let us be your advocate. We can ensure you are doing correct sales tax due diligence!
By: Brian Hollingsworth, Partner