State And Local Tax Insights - Fall 2012

State Tax Issues in Mergers, Acquisitions and Restructurings: Food for Thought

By Mitchell A. Newmark and Richard C. Call

Business mergers, acquisitions and restructurings involve legal, regulatory and tax components. Important among the tax components are various state tax issues that may include corporate income and franchise taxes, sales and use taxes ("sales tax"), as well as other taxes. In addition to considering taxes on the transactions, other state tax issues to be considered include potential liability for a seller's unpaid taxes, changes to a company's nexus and changes to reporting income. In this article, we highlight six state tax issues to consider: (1) tax bulk sales laws; (2) nexus; (3) instant unity; (4) state treatment of Internal Revenue Code ("I.R.C.") Section 338(h)(10) transactions; (5) sales taxes; and (6) real estate transfer taxes. The foregoing six considerations are several, but not all, of the myriad state tax issues to consider when engaging in such transactions.1

Tax Bulk Sales2

Many states have adopted tax bulk sales laws that may hold a purchaser of assets liable for a seller's unpaid state tax liabilities.3 Such laws are intended to: (1) minimize the risk that a seller will sell some or all of the company's assets without paying its outstanding state tax liabilities; and (2) provide an alternative means of recovery against the assets that may have contributed to the unpaid liability of the seller. The tax bulk sales laws should not be confused with the Uniform Commercial Code's bulk sales laws that address non-tax liabilities.4 Under the tax bulk sales laws, purchaser liabilities can include sales taxes, corporate income taxes and property taxes that remain unpaid by the seller. However, mechanisms exist to reduce a buyer's potential tax liability.

State Variations in the Types and Amount of Liability

For the most part, bulk sales laws operate by requiring an asset purchaser to withhold from the purchase price an amount equal to the seller's unpaid state tax liabilities for taxes that are subject to that state's bulk sales laws, including penalty and interest.5 If such amounts are not withheld (typically in escrow), the purchaser will be liable or the unpaid liability.6 The amount of a seller's liability that a purchaser may inherit varies by state. Some states limit a purchaser's liability to the amount of the purchase price, while in other states the liability for unpaid taxes may exceed the purchase price of the purchased assets.7 Some states apply bulk sales laws to "trust fund" taxes, e.g., sales taxes or withholding taxes.8 Other states apply bulk sales laws to additional taxes, including corporate income taxes.9 Moreover, the states are not uniform in their triggers for bulk sales laws. Some states' bulk sales laws apply when a business transfers a substantial amount of assets.10 In other states, the bulk sales laws are triggered if even an insubstantial amount of a company's assets are sold.11

Containing or Reducing Transferee Liability

States provide mechanisms for protecting a purchaser from becoming subject to the seller's liabilities. Complying with these mechanisms may be the responsibility of the purchaser or seller of the assets, but typically is not imposed on both the buyer and the seller. If the state imposes the filing duty on a purchaser, the purchaser may be able to avoid liability by timely filing a notice of the transaction with the state and withholding an amount equal to the seller's unpaid state taxes from the purchase price.12 In Colorado and Mississippi, the responsibility is imposed on a seller, yet the purchaser can also be liable for the seller's unpaid state tax obligations if the purchaser does not obtain a receipt from the seller showing that the seller has paid its tax obligations.13 Moreover, deadlines for complying with such mechanisms vary and may precede the closing date of the transaction, making it important that bulk sales issues be addressed as early as possible in a transaction.14

Nexus – Corporate Income, Corporate Franchise and Sales Taxes

Business transactions may result in changes to the states with which a company has nexus or is subject to tax. Inasmuch as the corporate income, corporate franchise and corporate gross receipts taxes have similar considerations, they are referred to together as "corporate income taxes."

Business Form May Affect the Nexus Consequences

The decision to operate a newly acquired company as a separate entity or as a division of the acquirer may have significant nexus consequences for purposes of corporate income taxes and sales taxes. For instance, take the example that prior to a transaction, Company A does not have nexus with State X, a separate entity reporting state. Company A acquires Company B, which has employees located in State X. Outside of the agency or affiliate nexus context, choosing to operate Company B as a division of Company A would result in Company A having nexus with State X.15 On the other hand, operating Company B as a separate entity should allow Company A to continue to not have nexus with State X.

The nexus consequences of operating a newly acquired business as a division or as a separate entity may affect corporate net income tax or gross receipts tax apportionment in combined reporting states. For instance, assume that under the above facts, Company A makes sales into State X, but is not subject to tax in State X because of Public Law 86-272. Assume for this example that State X is a combined reporting state, Company B is subject to tax in State X and when Company A acquires Company B the two companies conduct a unitary business. If State X uses a Finnigan rule, State X would require inclusion of Company A's sales into State X in the sales factor numerator, regardless of whether Company B was operated as a division or separate entity.16 However, if State X uses a Joyce rule, Company A's sales would not be included in the State X sales factor numerator if Company B is operated as a separate entity.17

Agency and Attributional Nexus Principles May Override Separate Entity Structures

The nexus consequences of operating a newly acquired company as a division or a separate entity may also depend on the extent to which agency or affiliate nexus principles apply. Several states assert agency or affiliate nexus theories as the basis for requiring a company that is not physically present in the state to collect sales tax or pay corporate income taxes. For instance, some states' taxing authorities have asserted that certain activities conducted by third parties with whom a company had no contractual relationship established a sales tax collection requirement for a company that was not physically present in the state.18 One of the broadest sales tax collection statutes was enacted in Oklahoma, which provides that an entity is presumed to have a sales tax collection requirement if the entity is a member of a controlled group of corporations (as defined for federal income tax purposes) where that controlled group of corporations has a component member (as defined for federal income tax purposes) that is a "retailer engaged in business in [Oklahoma]."19 The Oklahoma statutes define a retailer engaged in business in Oklahoma broadly to include:

[a] retailer [that] holds a substantial ownership interest in, or is owned in whole or in substantial part by, a retailer maintaining a place of business within this state, and . . . the retailer sells the same or a substantially similar line of products as the related Oklahoma retailer and does so under the same or a substantially similar business name, or the Oklahoma facilities or Oklahoma employees of the related Oklahoma retailer are used to advertise, promote or facilitate sales by the retailer to consumers,20

as well as:

[a] retailer [that] holds a substantial ownership interest in, or is owned in whole or in substantial part by, a business that maintains a distribution house, sales house, warehouse or similar place of business in Oklahoma that delivers property sold by the retailer to consumers.21

Franchise Tax Consequences

Franchise tax issues are also important to consider. For income tax purposes, a state's combined reporting rules may reduce the effects of exposing a company's income to tax as a result of a merger or acquisition, e.g., through statutes that eliminate intercompany transactions or assign sales under a Joyce rule. Unlike corporate income taxes, however, many state franchise or net worth taxes are imposed on a separate entity basis.22 Accordingly, intercompany elimination statutes and Joyce principles would not apply to mitigate exposure of the value of the merged companies to taxation in such a state.

Instant Unity – When, If Ever, Does an Acquired Company Become Unitary?

Another issue to consider in mergers and acquisitions is whether a newly acquired company has "instant unity" with the acquiring company. Two merged companies could become unitary the day of the merger or at a later date, depending on when the companies have functional integration, economies of scale and centralized management.23 Importantly, state statutes that provide a list of activities that necessitate a combined report, or contain elections to file combined or consolidated reports, may allow companies to achieve increased certainty with respect to their reporting positions.24

Statutory mechanisms that permit increased certainty with respect to the question of instant unity include a Colorado statute that permits combination only when at least three of the six statutorily enumerated criteria are satisfied for the current tax year and the two preceding years.25 These criteria allow taxpayers to size up their operations against a specific list before filing returns. Also, some states, such as Massachusetts, allow taxpayers to elect to file a consolidated return that is based, at least in part, on the taxpayer's federal consolidated group...