Acquiring the Assets of a Business? Don’t Forget About Sales Tax
By Tom Corrie, Principal, Tax & Business Services & Christian Burgos, Managing Principal, Tax & Business Services
The purchase of an existing business is generally structured in one of two alternative ways: purchase the entity outright, or purchase only the assets of the business. No matter how much due diligence is performed by the purchaser, skeletons have a way of appearing out of the closet after an outright entity purchase. Purchasers often find outstanding liabilities, legal exposure, and many other unwanted crises. For this reason, business asset purchases have become a widely accepted method of acquiring property. For the most part, the selling entity’s skeletons do not transfer to the purchaser of the business assets, making this structure more attractive. As an added benefit, purchasing business assets usually results in the buyer receiving a basis step-up in the assets, which provides future increased depreciation deductions. However, in all the negotiations, planning, and professional assistance, one hidden skeleton is often overlooked, namely, can the purchaser become liable for the seller’s unpaid sales tax? This includes potential liability for sales tax arising from ongoing business operations, as well as possible sales tax generated by the sale of the business assets. Without proper planning techniques, tax filings, and the applicable purchase price escrow, a purchaser may be liable for a shocking tax assessment.
Almost all states have statutes containing some successor liability rule on asset purchases, allowing the states to pursue a seller’s outstanding tax liability from an asset purchaser. A purchaser may be held liable for the amount of the seller’s unpaid sales tax, up to the higher of the sales price or fair market value of the assets being acquired. To protect purchasers, many states have implemented a notification procedure whereby a purchaser notifies the state’s taxing authority regarding the ensuing transaction. Upon receipt of such notification, the state authorities review the seller’s sales tax account for any unpaid tax. If any liability exists, the state will commence a collection action before the asset purchase is completed. The notification procedure ensures the seller’s payment of any outstanding sales tax and protects the purchaser from successor liability.
While most states follow this same basic approach, each state has its own particular nuances that must be adhered to in order to protect a purchaser. For example, New York provides specific requirements prior to entering a “bulk sale” – a sale in bulk of any part of business assets, other than in the ordinary course of business. Ten days before paying or taking possession of the business assets, a purchaser must notify the Department of Taxation and Finance by filing Form AU-196.10, Notification of Sale, Transfer or Assignment in Bulk. Within five days of receipt of the form, the Department must respond to the purchaser regarding any unpaid sales tax by the seller. If no tax is owed, a Form AU-197.1, Purchaser’s and/or Escrow Agent’s Release – Bulk Sale, will be issued to the purchaser. The purchaser is then permitted to pay the contract price without fear that New York will hold the purchaser liable for any outstanding taxes. Should there be an outstanding tax liability, the Department issues Form AU-196.2, Notice of Claim to Purchaser, and will seek payment of the tax directly from the seller. The purchaser should not pay for the assets until the liability is satisfied. However, if the purchaser releases the funds to the seller, the state has 90 days to assess the unpaid tax on the purchaser as the successor of liability.
Connecticut has a similar bulk sales provision. To avoid successor liability, a purchaser must request a Tax Clearance Certificate from the Connecticut Department of Revenue Services. The request must contain a copy of the contract and terms, expected location and date of the closing, and the tax registration numbers of both the buyer and seller. Receipt of the Certificate means that the seller has no outstanding tax obligations, and it relieves the purchaser from having to withhold a portion of the purchase price to cover any potential tax liability. Upon receipt of the request, the Department has 60 days to respond. Failure to respond within the 60 days results in the elimination of any successor liability on the purchaser. Since a buyer and seller may not want to delay a closing for 60 days, they can escrow a portion of the sale proceeds in the closing to be held until the receipt of Form AU-712, Tax Clearance Certificate for Sales and Use Taxes.
New Jersey’s bulk sales law also requires notification be provided to the Director of the Division of Taxation 10 business days prior to the transfer of any goods or payment. The notice is provided on Form C-9600, Notification of Sale, Transfer, or Assignment in Bulk. The state has 10 days to respond to the request. Failure to respond within the specified time will permit the purchaser to proceed with the transaction and bar any claim of successor liability on the purchaser. Of course, the purchaser has the option to escrow a percentage of the proceeds if he seeks to close the transaction prior to receiving notification from the Division.
Aside from preventing successor liability, most bulk sales statutes also provide an exemption for sales and use tax on the purchase of the business assets. This exemption applies to occasional or isolated sales which are not generally engaged in during the ordinary course of the seller’s business operations. For example, an accounting firm is typically not in the business of selling computers, therefore if the firm were to sell its computers the purchaser would be exempt from paying sales tax on the transaction. However, a concern that arises is the issue of applicable sales tax on the purchase of inventory. Unlike the bulk sales exemption for isolated sales, inventory is an asset held for sale in a business’s ordinary course of operations. In fact, many bulk sale provisions explicitly exclude inventory from the list of exempt assets. Fortunately, most asset purchases of inventory occur with the intention by the purchaser of reselling the inventory to the purchaser’s customers. Since virtually all states permit a sales tax exemption for the purchase of tangible personal property held for resale, asset purchases of inventory usually are exempt from tax. In the rare instance that inventory is not purchased for resale, sales tax would be applicable.
Interestingly, New York is one of only a handful of states whose bulk sales law does not exempt occasional sales. Thus, business asset sales in New York are subject to sales tax. For this reason, it is of great importance to separately delineate each asset and its sales price in a purchase contract occurring in the state. It is possible that other sales tax exemptions may be applicable to the specific items being acquired. For example, supermarkets are exempt from paying sales tax on the purchase of machinery and equipment used directly and predominately in the production of food for sale. Similarly, intangible assets, such as goodwill, are exempt from tax. Failure to specifically delineate each asset and its sale price would lump all of the business assets being purchased into a bundled group, all of which would be taxable.