IPT 2013 Sales & Use Tax Symposium – Monterey, CA 2013 Sales & Use Tax Symposium – Monterey, CA Presenters zJulie Stakenburg – Accenture, Director of US Indirect Tax – 415-537-5217

Sales and Use TaxIssues with Mergersand Acquisitions

IPT 2013 Sales & Use TaxSymposium – Monterey, CA

Presenters

Julie Stakenburg– Accenture, Director of US Indirect Tax– 415-537-5217– [email protected]

Steven Wlodychak– EY Center for Tax Policy, Principal, Washington,

DC– 202-327-6988– [email protected]

9/30/20132

Agenda

Sales tax implications of transactions– What is a Sales Tax? [A Refresher]– Implications for M&A

Sales tax on the transaction itself– Tax-free (?) transactions, mergers, asset transactions

Successor liability for historic tax liabilities of sellerSales tax on subsequent intra-group transactions amongrelated parties

M&A Case Study

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What is a Sales Tax?

Alaska Montana OregonDelaware New Hampshire

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A tax imposed on consumption of taxable goods andservices.Based on a percentage of the price of taxable goods orservices.Every U.S. state and the District of Columbia has asales tax, except five:

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Sales and usetaxes

AK

HI

ME

RI

VTNHMANY

CT

PANJ

DC

DEWV

NC

SC

GA

FL

IL OHIN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

ORID

NV

CAVA

MD

Key

No State Sales Tax (Alaska allows local sales taxes)

Hawaii and New Mexico business taxes operate as a sales tax

Local sales tax rules vary from state rules.

As of 08/12/2013

State sales tax map

No statewide tax,local sales tax only

What is a sales tax?

Rates vary by stateMost states permit county, municipal and district sales tax rates.

– 7,600 separate jurisdictions!Some states permit local variations in sales tax rules:

– Colorado home rule cities (Denver, Golden)Some states impose different rates on different goods or services

– Lower rates for:Grocery foodDrugs

– Higher rates for:Rental carsLodgingEntertainment

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Approx. Averagecombined state and localsales tax rate = 8.0%

Does the transaction involve asale of taxable goods/services?

Tangible personal property– Vehicles– Machinery– Clothing– Food– Software

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Taxable services– Personal services– Restaurants– Landscaping– Computer services– Security services

Key question to ask:– Is our Target subject to sales and use tax?

What isn’t subject to sales tax?

Most professional servicesIntangible Property

– Business entity interestsCorporate StockPartnership interestsLLC Membership interests

– Royalties, Copyrights, Trademarks– Goodwill

Real propertyInventory –

– (DON’T FORGET – Need for resale certificate.)

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What isn’t subject to sales tax?Exemptions

Product Exemptions (Not All States!)– Grocery food– Drugs– Machinery and equipment (NOT ALL STATES)

Transactional Exemptions– U.S. government purchases– State and local government purchases– Non-profit organization purchases (e.g., schools, hospitals,

churches)– Inventory (sales for resale)– Occasional, casual & isolated sales

SINGLE, MOST IMPORTANT EXEMPTION FOR M&A ASSET DEALS!!– ALSO: Specific exemptions for reorg/formation/divisive

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Sales tax on the transaction itself

Differing state approaches to sales tax onSubchapter C transactionsNo Set PatternMost complicated area of sales taxexemptionsSpecial bulk sale notice/reporting rules– Sales tax specific rules should not be confused

with UCC bulk sales requirement

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Cardinal Rules:1. Do NOT Assume that a transaction that is tax

free for federal income tax purposes is tax-freefor state or local sales tax purposes.

2. Do NOT Assume that just because a transactionis exempt for sales tax purposes in one state itis exempt in another.

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TRANSACTION RISK– Sales tax is imposed not on the gain on the transaction but on

the GROSS VALUE of the Taxable Assets transferred.Low Rates (compared to income tax) fail to gain attention of dealmakers– 8% sales tax rate vs. 40% federal and state combined income tax rate

BUT – Much larger base - Gross Purchase Price

– Sales tax only applies if transaction fails toqualify for exemption

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Example: $100m asset deal, Basis in assets is $90m, Purchase priceallocated $50m to tangible property

RESULTS: Gain = $10m X 40% = $4m

Sales tax = $50m X 8% = $4m ($0 sales tax for a STOCK deal)

Sales tax on examples ofSubchapter C transactions

Mergers– IRC §368(a)(1)(A) – Statutory merger– IRC §368(a)(2)(D) – Forward subsidiary merger

using parent stock– IRC §368(a)(2)(E) – Reverse subsidiary merger

using parent stock– Taxable Mergers

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Sales tax on the transaction itself– Mergers

Mergers – Statutory IRC §368(a)(1)(A)

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Assets andliabilities

P stockand boot

P stockand boot T stock

SH

P T

SH

PT

assets

1.Under state law, T mergeswith and into P. T transfersits assets and liabilities to Pin exchange for P stock.

2.Pursuant to the merger, Tliquidates, transferring the Pstock to its shareholders.

3.The transaction is tax free ifit qualifies as a statutorymerger and satisfiesvarious judicial andregulatory requirements(e.g., COI and COBE).


– Differing state approaches to sales tax onSubchapter C transactions

California– Statutory merger exempt (no conditions).New Jersey/New York– Statutory merger exempt, but “solely in exchange for the

issuance of its stock”.Oklahoma– Merger exempt, but only in exchange for voting stock

Sales tax rules are different

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Mergers – Forward subsidiary mergerusing parent stock IRC §368(a)(2)(D)

SH

P

ST

assets

Substantially allassets

P stockand boot

1. T merges with and into S,with S surviving. Tshareholders receive Pstock in the liquidation of T.

2. T assets and liabilitiesremain in S, separate fromP.

3. T shareholders do notrecognize gain on the Tstock exchanged for Pstock.

4. [Notes: Sub all requirement,no SH approval needed, noS stock can be used.]

P stockand boot

TS

P SH

P stockand boot

T stockS stock(fictional)


Mergers – Forward subsidiary merger usingparent stock IRC §368(a)(2)(D) – StateSales Tax Impact– New Jersey/New York

Transfer of property to a corporation solely inconsideration for the issuance of its stock, pursuantto a merger or consolidation.

– Triangular reorganization (e.g., IRC 368(a)(2)(D)) usingparent stock does not qualify for this exemption.

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Mergers – Reverse subsidiary mergerusing parent stock IRC §368(a)(2)(E)

T stock

SH

P

TS

assets

1.P forms S. S merges withand into T, with T surviving.T shareholders receive Pstock in exchange for their Tstock.

2.S liquidates by operation ofstate law.

3.T shareholders do notrecognize gain on the valueof T stock exchanged for Pstock.

T

SH

P votingstock and

boot

S

P

T stock

T stock

P votingstock and

boot

P votingstock and boot


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Mergers – Taxable merger

T stock

Assets

Cash and/orP notes

Cash and/orP notes

SH

TP

1. T merges with and into P,with P surviving.

2. T shareholders receivecash and/or P notes inexchange for their Tstock.

3. T shareholders recognizegain for Federal incometax purposes.


Occasional, Casual or Isolated SaleExemptions

– Broadly worded– In addition to (or supplemental of) other transactional

exemptions from sales tax.

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Sales tax on the transaction itself– Asset deals

Occasional, Casual or Isolated SaleExemptions– Types of occasional sale rules:

Number of sales (Objective)– California – No tax if no Seller’s Permit; 3 Strikes Rule– Kentucky – 3 Strikes Rule

Type of sales (Subjective)– Texas – Sale of the entire operating assets of a

business or a separate identifiable segment of thebusiness.

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Other possible exemptions– Resale

To the extent inventory is to be acquired:– Register the acquiring entity for sales tax in each state

where inventory is located before the transaction closes.– That way, it can deliver a valid resale exemption certificate.– Consider closing condition for Buyer to deliver a resale

certificate at closing (even if you are the buyer)

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Other possible exemptions– Manufacturing equipment exemptions

To the extent that any of the assets to be acquired includemanufacturing or processing equipment:

– Many industrial states (typically in the Northeast and South)exempt manufacturing equipment from sales tax.

Some require exemption documentationCarefully understand specific rule and qualify each itemof equipment for the applicable exemption

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Other possible exemptions– Electronic delivery of software

Some states exempt from sales tax computer software that isdelivered in electronic form (e.g., California).In an asset purchase, if substantial value is attributed tosoftware and no other exemptions are available, considerwhether the transaction can be structured to deliver thesoftware component of the assets in electronic form to qualifyfor the exemption.

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Sales and use taxes – SuccessorLiability

Liability on the sale of a business– General income tax rule:

Income tax liabilities do not follow with the purchase of assets of abusiness.

– General sales tax rule:Sales tax liabilities follow with the purchase of thesubstantially all of the assets of a business.

Successor Liability for Sales TaxCaveat Emptor - Buyer Beware!Sales tax follows “legal” form of the transaction

– No sales tax on IRC §338(h)(10) election –But beware of special rules (California SBE “ruling”)

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Sales and use taxes – SuccessorLiability

Liability on the sale of a business– Buyers can protect themselves

Tax Clearance/bulk sales notices– May delay transaction– May trigger sales and use tax audit– Withholding on part of purchase price to

meet tax liabilitiesContractual IndemnificationDue Diligence

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Sales tax problems oninter-corporate transfers

Inter-corporate transfers– Sales and use taxes may be important in how a transaction

is structured.Post-acquisition considerationsAre significant inter-corporate transactions anticipated?

– Inter-corporate transactions may be taxable.– Intra-group transfers within a division may be exempt.– Caution on the reliance upon transfers between disregarded

entitiesAll but five states follow the disregarded election for sales tax(AL, MO, SC, TN, WI) –

– For all others, a transfer is deemed to be between two entities

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Sales tax problems oninter-corporate transfers

Example of inter-corporate transfer rules– Alabama

Exemption for inter-group rent, but not other transfers

– HawaiiNo exemption from gross receipts tax for intergrouptransfers, including services.

– OhioTaxable services provided by sub to parent taxable.

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M&A - Transaction Case Study

Facts– Proposed transaction:

Acquisition of Target stockSmall, non-public, closely-held corporation

– Target business line:Provider of information technology (IT) “services”

– Target management discloses they ignored sales taxcollection since the are a “pure service provider”

– Not registered for sales tax ANYWHERE

THIS IS A VERY COMMON SCENARIO

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M&A - Transaction Case Study –Information Request

Key information request to identify possibleexposures

– Purchase agreement– Disclosure schedules– Client Contracts if allowed or contract templates– Tax Returns

State income tax returnsSales tax returnsGross receipts tax returnsBusiness license returnsProperty tax returns

– Business Interview

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M&A - Transaction Case Study –Information Review

Look for Inconsistencies– Purchase agreement

Significant internally developed/purchased software IP listed– Disclosure Schedules

Resale contracts for third-party goodsClient contracts with software licensesClient contracts for implementation services of internally developed IP

– Client contract (if allowed) or contract template reviewSoftware licenses (w/ or w/out electronic delivery language)Data processingStaff Augmentation

– Category often missed as taxable in several statesPA, CT, HI, NM, OH, SD, WV

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Tax return review– Where does the target have

SalesEmployeesProperty

– Review the audit history and notices– Keep in mind that tax return information is helpful but

depending on the state rules, services sourcing is often to aclient location – office, server, etc.

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Business interview– How are sales initiated?

Remote sales force?Client site visits – single, multiple?

– Where are contracts concluded?– How are services delivered?

Remote location?Client site?

– Does service delivery depend on the type of service performed?Remote vs. client site

– To the extent services are delivered to a client siteHow long is the Target’s employee at the client site?Is it a one time effort?Does the Target send customer service reps periodically to meet with theclient?

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M&A - Transaction Case Study –Contract Negotiations

Tax related contract sections –– Assign clear responsibility (to buyer or seller) for tax filings pre- and post-acquisition– Allows for an escrow reserve or lowered purchase price

Escrow account– Pro

Cash has been set aside for sales & use tax payments– Con

Target traditionally wants more control, documentation, proof of paymentsLowered purchase price

– ConDeal team does not always remember to set aside funds for the VDA’s

– Allows for filing of VDA – remember if returns have not been filed there is NOSTATUTE OF LIMITATIONS

No approval from target preferable

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M&A - Transaction Case Study –Contract Negotiations

Review liability sections to ensure they areconsistent with tax sectionsOften contract sections will refer to“materiality” –– Understanding what constitutes materiality and

how it will apply to indirect taxes is criticalControl of XYZ letters, VDA filing, payments

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M&A - Transaction Case Study –Publically Traded Companies

Unique Issues– Traditionally, shareholder indemnity or escrow

won’t be allowed– Unfiled tax returns are the responsibility of the

purchaser

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Questions?

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Sales and Use Tax Issues with Mergersand Acquisitions

Documents

IPT 2013 Sales & Use Tax Symposium – Monterey, CA 2013 Sales & Use Tax Symposium – Monterey, CA Presenters zJulie Stakenburg – Accenture, Director of US Indirect Tax – 415-537-5217