Due Diligence
Thinking About an Acquisition? Do Your Due Diligence!
When entertaining discussions about mergers and acquisitions ( M&A ), due diligence practices as they pertain to the state tax side of a deal are a key item. We frequently consult with clients that are in the process of either acquiring another company or looking to be acquired. In either case, the client wants to be aware of any potential state tax exposure areas so they can move forward appropriately and correctly negotiate the deal.
Often however, the due diligence process is the first time the company has addressed the multi-state landscape. Sometimes M&A deals fall apart because a target company does not have its sales tax house in order. If a suitor company does its due diligence and finds significant exposure related to years of non-compliance with sales tax collection or income tax filing, it can either derail an entire deal or significantly impact the purchase price.
What are Some Due Diligence Questions to Ask if a Company is Being Acquired?
If a company wants to be acquired, we recommend examining the multi-state footprint and potential state tax exposure prior to beginning the negotiation with potential suitors. In the due diligence process, companies will want to determine the states in which they may be liable for underreporting and then assess the potential liability.
For example:
- What are the activities of employees or third-party contractors in states beyond the company’s “home state?”
- Has the company created nexus (either physical presence or economic nexus)?
- Should the company have been filing income taxes or other business taxes in a state for the last several years?
- If so, what is the extent of the potential unreported liability?
- Is the company obligated to collect and remit sales tax? When did this requirement start?
- How does the Wayfair ruling on economic nexus impact prior exposure?
With an average sales tax of almost 9 percent, a growing company that has been incorrectly treating its sales tax obligations can wrack up significant liability very quickly.
Due Diligence Questions to Ask if a Company is on the Acquiring Side
If a company is on the acquiring side of the fence, we recommend exercising similar caution when reviewing the target company activities. You’ll want to ask questions like:
- Does the company engage in multistate activities?
Where are they currently filing state business taxes?
How long have they been filing? - Have they recently (within the last 2 years) conducted a nexus review or taxability study?
- Has it been well-documented in their files?
If the answer to any of these is no, we recommend performing an extensive review to estimate possible exposure before the purchase.
M&A transactions often require the input of service providers across a wide spectrum-to include federal tax, state tax and sometimes international tax specialists. While a transaction may be structured a certain way for federal tax purposes, it’s important to note that not all states follow all of the federal M&A provisions.
Even after a deal is completed and contracts are signed, the acquired company generally needs to do remediation work to come into compliance. We can help the acquired company reduce its potential liability through a series of remediation efforts such as voluntary disclosure agreements, working with their customers to determine if they have self-assessed taxes, etc. The initial holdback amount or escrow reserve set by the buyer is often a conservative number that can be significantly reduced through some effort!
Most importantly, no matter which side of the deal a company is on, upfront due diligence is a must. We can assist with that.
