S-10 JANUARY 19-25, 2015 CORPORATE GROWTH & M&A Advertisement BEST PRACTICES Identifying state and local tax exposures during an acquisition T liability rules are often broader at the state and local levels. In addition, potenax due diligence often focuses on tial tax exposures for items such as sales the identification of tax and use tax can also be very high exposures at the federal since they are often calculated level. This is often approbased on a percentage of the proceeds priate due to the high federal tax as opposed to the income earned on rate imposed on underreported the transaction. income and the fact that major Tax due diligence should be contransactions are reported on the ducted for state and local taxes such WOOLLEY federal return. However, the as income, franchise, gross receipts, identification of tax exposures sales, use, property, payroll, and others. at the state and local levels can often be Some areas where tax due diligence is even more important since successor particularly important include: BY BOB WOOLLEY AND JULIE CORRIGAN ENTITY TYPE Tax due diligence should be conducted to determine whether the entity is filing pursuant to its correct tax classification. For example, some entities are required to separately elect to be taxed as S corporations in a state. Some states impose entity level taxes on a pass-through entity even though the taxation of the entity passes through to its owners for federal tax purposes. The exposure for these entity level state taxes should be clearly identified since there is often successor liability for these taxes even in an asset transaction. an exemption exists. If a company fails to collect the sales tax from its customers, most states consider the tax to then be a liability of the seller. TAX LIABILITIES When the assets of a business are sold, certain taxes may apply to the transaction itself and may become due within a short period of time following or even at the time of the transaction. A major component to transaction-based taxes is the sales tax on the transfer of assets. Generally, all sales of tangible personal property are subject to sales tax unless an exemption applies, such as the casual sale or resale exemptions. These exemptions should be investigated since they vary widely by state and usually have limitations for items such as titled assets. If a transfer tax applies, it is imperative to understand the different components within an asset transaction. Obtaining a valuation that itemizes the different assets included in the deal is often necessary in order to bifurcate the assets that may be subject to sales tax versus the assets that can clearly be excluded from a sales tax calculation. The buyer may be responsible for these transfer tax liabilities depending on the form of the transaction, contractual provisions, and the state involved. Performing tax due diligence for state and local taxes can assist the buyer in identifying the various exposures that may exist. Once an item of exposure is identified, it can be very challenging to quantify it, depending on the capability of the seller’s systems and processes. For example, the seller might not be able to extract the appropriate apportionment data if its systems have not been designed to capture this information at the point of sale. However, the buyer may be able to protect itself in negotiating the deal if the nature of the exposure is identified. NEXUS One primary issue relates to whether the business or business owners have filed tax returns in every jurisdiction where they are required. The nexus issue is critical for tax due diligence since statutes of limitations often do not begin to expire until tax returns are filed. As a result, the tax exposure is often not limited to the target company’s most recent tax years. This question of nexus can be determined differently depending on the underlying tax involved. For example, the threshold to create nexus for sales and use tax purposes is often less than the threshold for creating a filing requirement for income taxes. Since our founding in 2001 we have maintained a consistent investment style that has gained national respect across various industries and business communities. Resilience Capital has invested in 41 companies under 23 platforms. It’s portfolio companies today employ more than 7,000 people in more than 20 states and collectively represent over $2 billion in revenues. Resilience manages in excess of $625 million for it’s global institutional investor base. We partner with organizations to help them achieve their full potential and embark on sustainable value creation. APPORTIONMENT METHODOLOGY Another issue often relates to whether a target company is apportioning its income appropriately between the states. Different states impose different apportionment rules depending on the nature of the underlying business. This can result in a company being taxed on more than or less than 100% of its total income. Another common area of concern that has the tendency to become a large exposure item is the non-collection of sales tax or the lack of proper documentation for exempt sales. Taxpayers should generally obtain exemption certificates from their customers to be relieved of the obligation to collect sales tax. When sales tax nexus exists, states require companies to collect and remit sales tax from their customers on the products (and sometimes services) they sell, unless SALES TAX HELPING COMPANIES THRIVE AND ENDURE www.resiliencecapital.com Bob Woolley is a Partner in the State & Local Tax Group for Plante Moran. Contact him at bob.woolley@plantemoran.com or 614-222-9160. Julie Corrigan is a Senior Manager in the State & local Tax Group. Contact her at Julie.corrigan@plantemoran. com or 216-274-6509. Crain’s Cleveland Business Custom Publishing