Given the complexity of state and local tax (SALT) transactions, we’ve answered eight of the most frequently asked questions about the topic.
Q: When acquiring a company, what should a CFO be concerned about from a SALT perspective?
A: The first priority is conducting due diligence on potential SALT exposures. Due diligence is particularly important for an equity purchase because all of the target’s state tax exposures transfer with the entity. Even with an asset purchase, the CFO may have significant concerns regarding successor liability. For example, partnership sales that are treated as entity sales for federal tax purposes are, in fact, asset sales for most state taxes.
Q: How does successor liability apply to an asset sale?
A: Historically, states have enacted successor liability laws in regard to sales tax. Similarly, property taxes (whether real or personal) usually transfer with the underlying property. The same is true for unclaimed property that is potentially subject to escheat, such as accounts payable or receivable. What may be surprising, however, is that states are amending laws to extend successor liability to any of the seller’s unpaid income taxes.
Q: Is there a way to mitigate successor liability from an asset sale?
A: Yes, but the “cure” might be worse than the “illness.” If a liability is detected, then a state typically enforces successor liability by imposing a lien on the target assets. The state may also refuse to register the buyer for sales tax collection purposes. However, entities can avoid this result by complying with a state’s bulk-sale notification requirement prior to the sale. The potential problem with this solution is twofold:
- First, the buyer has to put a suitable portion of the purchase price in escrow.
- Second, the monies are not released until after the state conducts an audit of the target, which can take several months.
For these reasons, the successor liability concern is usually handled contractually and with very nuanced language.
Q: Let’s look on the bright side. If liabilities often transfer to the buyer, then should credits and incentives transfer as well?
A: Whether in regard to an equity or an asset deal, prior credit and incentive negotiations should be evaluated to determine whether they will withstand the transaction. The buyer should be prepared to reach a pre-sale agreement with the applicable governing jurisdiction to secure any credits and incentives. For example, in an asset deal, future tax credits typically remain with the selling entity and do not transfer to the buyer. PILOT (short for “payment in lieu of property tax”) agreements may not remain through the transaction. In addition, credit recapture provisions may be triggered if an asset is disposed of prior to a required holding period. Such a clawback may require the seller to repay previously claimed tax credits and/or lose any unused credits.
Q: What else should a CFO know?
A: CFOs should know that transactions can be subject to sales tax and/or real estate transfer tax. Sales tax would apply only to an asset sale, but several states have extended real estate transfer tax to both asset and equity sales. Inventory is always exempt from sales tax. In regard to non-inventory tangible assets, some states will exempt the sale as a casual or an isolated sale while others will not. Even in those states that have an exemption, there are several requirements that a seller can easily miss. Overlooking the requirements could result in sales tax being imposed on the value of all the transferred taxable assets.
Q: What effect could a transaction have on the buyer’s or seller’s SALT liability?
A: Mathematically speaking, a new entity or set of assets will have either a positive or negative effect on both the buyer’s and the seller’s state income tax. This impact may occur through apportionment changes or through filing methodologies (e.g., combination). With regard to property tax, the acquisition may trigger a reassessment of real property. The State Unemployment Insurance (SUI) rate and account balance of the purchaser may be impacted. In some states, the payroll tax withholding obligations could also be affected. Additionally, SUI rates may transfer to the purchaser if any employees are transitioned as part of an asset acquisition.
Q: Are there any post-sale SALT implications of a transaction?
A: Post-acquisition integration would ideally include SALT. Many compliance policies and processes for several state and local taxes will be affected. A transaction may result in nexus in additional states or additional taxes – and these taxes will require additional compliance. The new business might require sales tax collection and/or use tax remittance obligations, thereby increasing both liability and compliance. Perhaps the buyer will need to register as a vendor and obtain a seller’s permit in certain jurisdictions so that it can collect and remit taxes from customers. Overall, the transaction will likely affect the liability, accounting, and compliance processes of several of the buyer’s state and local taxes.
Q: How could a SALT transaction change a compliance process?
A: For example, a buyer may need to assess its sales tax reporting process to determine whether that will require an upgrade. The assessment might reveal that the increased sales tax reporting obligations require a shift from a manual tax reporting process to an automated system. A buyer that already has an automated tax reporting system will most likely have to make program changes to enable it to do the following:
- access the appropriate information associated with the new filing jurisdictions and/or new products, and
- properly report the tax for compliance purposes.
In some cases, the buyer may determine that the existing automated system requires an upgrade to address the more-involved sales tax compliance burden.
Please contact us if you have additional questions related to your organization’s current or potential SALT transactions.