Acquiring property? Remember sales tax due diligence.

• Author: Rennie, Dave

As the mergers and acquisitions market continues to heat up, so should the scrutiny of sales tax in the due diligence review. Unlike income tax, sales tax is transaction-based and applies to sales, regardless of whether the company is in a profit or a loss position. A company can be financially sunk by a significant and unforeseen sales tax assessment.

A buyer of a company should be aware that sales tax successor liability generally applies to the purchase of a business, even an asset purchase. A due diligence review can reduce the surprises and, in some circumstances, enhance negotiations for a reduced sale price.

Nexus and Tax Exemptions

The biggest sales tax exposures generally result from a failure to (1) register and collect tax in a state and (2) collect tax based on an erroneous decision that the receipts are not subject to tax. Many companies are caught off guard by inquiries from distant states and are surprised at the low nexus standards for sales tax. "Nexus" is defined simply as the minimum connection or physical presence that must exist before a state can impose tax liability and reporting requirements on a company. The Supreme Court ruled in Quill v. North Dakota, 504 US 29 (1992), that a "physical presence" exists by the temporary presence of property, inventory, employees or independent representatives in a state.

However, states vary in interpreting the degree of physical presence required. For example, 11 visits to Kansas during three months of a four-year audit period were insufficient to establish nexus; see In the Matter of Appeal of Intercard, 270 Kan. 346 (Kan. 2000). Arizona concluded that the presence of employees in the state for more than two days a year establishes nexus; see Arizona Dep't of Rev., Pub. 623, Nexus in Arizona, May 2006. "Nexus with Texas" can be established by a single day's visit to the state by either an employee or an agent.

Generally, a target company with sales representatives promoting its products across the country has established nexus in most states. If that company has not registered with the states and reported sales tax, it potentially owes sales tax, interest and penalties for past years on taxable sales in those states.

Another common error is mistakenly concluding that the sale of a product or service is exempt from sales tax. Sales tax determinations can be challenging for the advanced business models of many target companies; mixed transactions involving the sale of services and...