Colorado Business Asset Acquisitions: a Tax Trap for the Unwary

• Publication year: 1997
• Pages: 65
• Citation: Vol. 26 No. 9 Pg. 65

26 Colo.Law. 65 Colorado Lawyer 1997.

1997, September, Pg. 65. Colorado Business Asset Acquisitions: A Tax Trap for the Unwary

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65

Vol. 26, No. 9, Pg. 65

The Colorado Lawyer
September 1997
Vol. 26, No. 9 [Page 65]

Specialty Law Columns
Business Law Newsletter
Colorado Business Asset Acquisitions: A Tax Trap for the Unwary
by Darren R. Hensley, Thomas O. McGimpsey

Column Ed.: David P. Steigerwald of Sparks Dix, P.C., in Colorado Springs - (719) 475-0097

This newsletter is prepared by the Business Law Section of the CBA to apprise members of the Bar of current information concerning substantive law. This month's article was written by Darren R. Hensley, a partner, and Thomas O McGimpsey, an associate, in the Business & Finance Department of the Denver office of Ballard Spahr Andrews & Ingersoll, (303) 292-2400

Practitioners often overlook Colorado sales and use tax provisions in business asset acquisitions, exposing their clients to potentially substantial penalties and interest Because the Colorado sales and use tax provisions are unusual in that they do not explicitly provide an exemption for most occasional sales of tangible personal property, such as business asset sales, these provisions provide a tax trap for the unwary practitioner.

Given these realities, practitioners in an asset purchase transaction must be prepared to advise their clients regarding: (1) the proper characterization of each purchased asset (for example, as real property, fixtures, machinery, machine tools, furniture, leases, equipment, supplies, vehicles, inventory, raw materials, software, intangibles, or goodwill) to take advantage of the various exceptions and exemptions from the tax, and (2) the tax ramifications of allocating the purchase price among such assets. To that end, this article outlines certain aspects of the Colorado sales and use tax provisions and their application to a typical asset acquisition.1

Sales and use taxes imposed by local governments2 and various special districts3 are not discussed in this article; however, practitioners are encouraged to investigate the existence and applicability of such taxes as they relate to a particular transaction.

Sales Tax

The Colorado Emergency Retail Sales Tax Act of 1935, as amended ("Act"),4 imposes a 3 percent sales tax on the purchase price paid or charged on all sales and purchases of tangible personal property at retail.5 Unlike the statutes of most states, the Act does not explicitly provide an exemption for occasional sales of tangible personal property (other than sales by charitable organizations and farm close-out sales), such as the sale of the assets of a business.6

While the Colorado Department of Revenue ("Department") has determined that a stock acquisition of a business is not subject to sales and use tax because it is the sale of a nontaxable intangible asset,7 an asset acquisition of a business is taxable as a "retail sale."8 The Colorado Code of Regulations ("C.C.R.") provides that a purchaser shall remit sales tax on the price paid for tangible personal property acquired with a business and for use or consumption in that business.9 Therefore, an exemption from sales tax for asset acquisitions must result from (1) exceptions to the definitions of "tangible personal property" or "sale," (2) exemptions for specific types of assets, or (3) the type of transaction, such as a purchase for resale.10

Intangibles

The Act imposes sales tax on sales of tangible personal property and then defines "tangible personal property" as corporeal personal property.11 No sales tax is imposed on the sale of intangible personal property in an asset acquisition,12 and exempt intangibles generally include items such as contracts, deeds, mortgages, stocks, bonds, certificates of deposit, goodwill, copyrights, trademarks, patents, licenses, accounts receivable, and certain software.13

Software

Although practitioners may commonly view software as exempt intangible personal property, additional analysis is required. The C.C.R. provides that software is exempt only if either the preparation or selection of such software required an analysis by the vendor of the customer's requirements, or the software program required adaptation by the vendor to be used in a specific output device.14 Generally therefore, a vendor's sale of most prepackaged software (and related maintenance agreements, if any) will be subject to sales tax, whereas a vendor's sale of custom software will be exempt from sales tax.

Notably, however, software sales in an asset acquisition may not fall squarely within the exemption because (1) the seller may not be a "vendor" under the regulations, or (2) the seller, in most cases, does not modify the software to meet the purchaser's specific requirements. To date, no interpretive guidance has been given regarding the applicability of this exemption in an asset acquisition.

Separate and apart from the above analysis, the C.C.R. also imposes sales tax on the sale of internal systems software that is not normally accessible or modifiable by the user.15 The regulations view such software as part of the hardware of the computer.

Inventory

The Act imposes sales tax on all sales of tangible personal property at retail and then defines "retail sales" as all sales made within Colorado except wholesale sales.16 A "wholesale sale" is defined by the Act as a sale by wholesalers to retail merchants, jobbers, dealers, or other wholesalers for resale, and does not include a sale by wholesalers to users or consumers not for resale.17 Therefore, any sale that does not qualify as a "wholesale sale" falls within the category of "retail sale."18

The classification of a sale as a "wholesale sale" or a "retail sale" depends entirely on the disposition of the purchased goods by the purchaser.19 The test for determining if a purchase is a purchase for resale is whether the primary purpose of the transaction is the acquisition of tangible personal property for resale in an unaltered and basically unused condition by the purchaser.20

Inventory of finished products, in most cases, is purchased for subsequent resale in an unaltered and basically unused condition, making the purchase of inventory in an asset acquisition a "wholesale sale" under the Act.21 Moreover, inventory is specifically excluded from the sales tax remittance provision of the C.C.R.22 Accordingly, the Act imposes no sales tax on finished products inventory in an asset acquisition.23

Raw Materials

Unlike inventory, raw materials are expected to be altered before...