Due diligence is the process of investigations and analysis into the details of a company prior to an acquisition of its shares or assets or in preparation of an IPO. While financial, legal, operational, and income taxes of the company are generally considered, state and local non-income based taxes should not be left out of the analysis. These taxes are sometimes the reason a buyer decides not to proceed further, yet this is an area that is often overlooked.
State income taxes may be the most material state tax for the company and an appropriate place to start. However, in some cases, other uncovered state and local taxes may eliminate economic gains anticipated as a result of the transaction. Therefore, due diligence should include franchise taxes, city taxes, withholding, property taxes, sales and use taxes and even unclaimed property.
Franchise and Gross Receipt Taxes
A company that does not have sales personnel traveling to various states may still have a state tax return filing obligation in the state if the company is registered to do business in the state subjecting the company to possible minimum fees, franchise tax or net worth based taxes. A company that is not registered in a state nor has personnel traveling to the state may still have a gross receipts tax filing obligation for various taxes like the Ohio Commercial Activities Tax or the Washington Business & Occupation Tax.
City Business Taxes
Many cities and municipalities have income tax or other business entity taxes including Philadelphia, Detroit, New York City, Ohio cities and Kentucky counties. If the company currently files or has presence in a state that also has a city, county or other local business tax return, should the company also be filing a business tax return at the local level?
Does the target company have employees that travel to the states to perform duties such as meet with customers, perform services or deliver product? If so, then the company could be required to withhold employment taxes on this mobile workforce. Given these complex and various rules for withholding, it is not surprising that many companies either do not know or do not follow these withholding rules consistently.
Although it is common to review historical property tax liability, one significant property tax issue is the effect of the merger or transaction itself on the assessed values. Many transactions are publicized greatly and property tax assessors will often utilize the press releases to increase assessments instead of subsequently rendered returns. Please be aware of the impact that a published company sales price may have on the property tax liability.
Sales and Use Taxes
There are various sales and use tax issues that may arise, however there are three primary issues that may have significant impact on a merger or acquisition. Is the merger or acquisition as a whole or in part a taxable transaction? Has the target company correctly determined the taxability of its purchases and sales and has use tax been accrued? What effect will the merger or acquisition have on nexus? Has nexus been created by the merger especially given the acceptance of affiliate nexus by many jurisdictions?
Any of these situations can result in significant successor liability. Often indemnity provisions in the purchase contract are not helpful since the issues are usually not discovered until an audit which often occurs after the indemnity period has expired.
Unclaimed property can have look back periods of over 20 years. Many states are very aggressive in the pursuit of unclaimed property.
In conclusion, when analyzing the risks of a potential acquisition, the buyer should review all aspects of the target company, including state and local non-income based taxes before proceeding further.
For additional information on this topic, please contact your local UHY LLP professional or the authors of this article:
UHY Advisors’ National State and Local Tax (SALT) Managing Director
UHY Advisors’ Leader of the Multistate Income & Franchise Tax Practice in Texas