Sales Tax Due Diligence in a Post Wayfair World
Over the past five years, sales tax awareness has increased amongst the private equity world as states have expanded their ability to tax remote sellers through economic and marketplace nexus rules. However, as a result of the South Dakota v. Wayfair, sales tax has worked its way to the top of the due diligence list.
As a matter of fact, the enforcement dates for many states began as early as July 1, 2018, resulting in any deal currently in the pipeline potentially facing major sales tax exposure that may affect your ASC 452 accrual – and as a result, directly impacting EBIDTA.
What is the result of South Dakota v. Wayfair?
For those private equity professionals that have not returned from the Hampton’s yet, here is what happened. The Supreme Court recently released its decision on the landmark sales tax case, South Dakota v. Wayfair. The Court overturned the “physical presence” standard that previously governed the determination of when sales tax was due. Wayfair held that the correct standard in determining the constitutionality of a state sales tax law is whether the tax applies to an activity that has “substantial nexus” with the taxing state.
State officials around the country are in the process of exploring and/or implementing a range of possibilities for taxing sales by remote sellers to take advantage of the new economic Wayfair test and the landscape is changing rapidly.
States That Have Announced Legislative or Administrative Rule Changes as of August 1, 2018
The Wayfair decision has made it critical for remote sellers to review their current business against existing and quickly evolving state legislation in order to make determinations as to which states they may now be required to collect and remit sales tax.
What is a Remote Seller Under Wayfair?
Many professionals are confused and have made an assumption that Wayfair only applies to e-commerce transactions. This is not the case. Although many states have not clarified the definition of a remote seller, several have, and the definition is broad as states will cast a wide net.
For example, Nebraska defines remote sellers as “retailers that do not have a physical presence in Nebraska, but sales to purchasers in Nebraska” and Maryland defines a remote seller as anyone whom “sells or delivers tangible personal property or a taxable service for use in Maryland”.
Why Should Buyers be Aware of Sales Tax Exposure Immediately?
Buy-side investors should have two major concerns on any deals currently in the pipeline. First, although historical exposure may be limited at this point due to the short period of time since the decision was released, certain states have had rules in place for years, that have now been validated by the Wayfair case.
For example, Massachusetts and Rhode Island have recently issued guidance that they have had economic nexus rules in place since 2017 and that the Supreme Court ruling has validated their position. They have not stated that there is a future enforcement date and they may assert that sales tax is due since the inception of the bill. Prior to Wayfair, many companies have taken an aggressive position with states that enacted an economic nexus rule. Those aggressive positions can become future liabilities.
Second, the buyer has to be prepared to collect sales tax in new states immediately. For example, a typical software company with revenue of $50M and physical presence in three states may have been previously collecting and remitting sales tax in three states.
However, an economic nexus evaluation report on those sales showed that the company will have sales tax filing requirements in 12 other states by October 1, 2018. How are you going to implement this process in three months? What will be the additional compliance cost? Will you need to implement a sales tax compliance software solution? What is the company’s exposure for every month the process is not in place?
Needless to say, buy-side investors need to be prepared for a post-Wayfair world. Sales tax liabilities will grow quickly if proper systems are not in place. These costs will impact the bottom line and in most states, the liabilities can be attached to owners and officers of the company.
Purchase agreements need to include strong language to protect the buyer. In some cases, we are seeing buyers passing the cost of future compliance to the seller, including the cost of consultants to correct non-compliance matters. This same information needs to be properly communicated to management, so expectations are set about the future cost of sales tax compliance.
PMBA has been assisting clients with complex sales & use tax matters for over 15 years. If you have any questions regarding the new developments from Wayfair feel free to call Chris Vignone at (914) 219-0625.