By Aftab Jamil and David Yasukochi, BDO, USA, LLP
Full Impacts on M&A to Be Seen in 2020
Because Wayfair was decided in June 2018, its impact on deal making won’t be fully understood until after 2019 and beyond as potential buyers evaluate the consequences of Wayfair on financial metrics and potential contingencies.
For instance, deals involving foreign buyers may be delayed as these entities seek to understand how remote sales tax collection might affect their business. For foreign companies, Wayfair proves a bit of a paradox: On the one hand, they may see the benefit in striking a deal with a U.S.-based company that has a better grasp on the sales and use tax system, but on the other, the complexities around Wayfair and the amount of education required to understand the U.S. sales tax system may prove too intimidating for a prospect to tackle, even with a U.S. deal partner.
Of course, the nature of being a U.S. domestic company doesn’t mean being automatically endowed with all the knowledge required to be in compliance with Wayfair. Given the potential complexity, even companies with knowledge of their sales and use tax requirements may not be able to easily comply with their obligations. In fact, our Technology Outlook survey found that more than two-thirds (68%) of tech CFOs harbor high or moderate concerns about tax changes in 2019, with changes required by the Wayfair ruling driving 10% of that worry. Meanwhile, 60% of tech CFOs expect to pursue M&A in 2019, and 53% intend to pursue it for an exit strategy. Valuations will require additional due diligence and scrutiny of tax liability for all parties involved.
Take, for example, a U.S. technology company being acquired by a private equity firm. Though the company had implemented a robust sales tax determination engine for the 35 states into which it made sales, it hadn’t employed subject matter experts to verify whether its products were correctly mapped to the proper code for the purpose of determining whether sales were subject to tax in a given state. Incorrect mapping resulted in a material historical sales tax liability prior to the acquisition, necessitating pre-close clean-up and precious time spent before the deal was closed.
If you are considering a sale and believe you may have uncollected sales and use tax exposure in a state, there are paths to remediation. To avoid a liability and payment of interest and significant penalties for failure to file, technology companies should engage a professional service firm to anonymously reach out to states with material exposure amounts by participation in a VDA, whereby the company acquiesces to payment of the historical liability while having the benefit of a limited lookback period (often three years) and a penalty waiver.
Some companies have chosen to file on a prospective basis, thereby ignoring the historical nexus and related exposure. This has resulted in sales tax assessments for prior years, by preventing their ability to negotiate a limited lookback period, since most voluntary disclosure programs are not available for a current registered taxpayer. For technology companies that have been making sales for seven, eight, or more years, this means their liability (and interest and penalty payments) may double or triple what they would otherwise have been required to pay had they qualified to enter into a VDA with the ability to take advantage of a limited lookback period.
Compounding Complexity: Marketplace Facilitator Tax Laws
While Wayfair has obvious effects on the e-commerce sector, its impact also extends to the middlemen of retail software and hardware sales transactions. As the year continues to unfold, unforeseen exposure for both retailers and these middlemen has the potential to have great impact as companies begin to understand their collection and reporting responsibilities.
New sales tax laws are now requiring marketplace facilitators—third-party entities that facilitate sales such as Amazon—to collect and remit sales and use taxes on behalf of retailers. In the technology industry, an example is a consumer purchasing TurboTax software through Amazon. These laws help to substantially reduce the number of remote sellers that state tax authorities may seek to audit. We expect nearly all states will enact marketplace facilitator tax laws in the near future.
By nature, marketplace facilitators don’t have intimate knowledge of the goods or services being sold as the retailers themselves. This lack of familiarity could result in a fair amount of under-collected sales tax if these sales are not properly accounted for or mapped to the correct taxability classification. Also, this under-collecting is compounded by the fact that there is lack of clarity around who should ultimately be responsible for the correct amount of sales taxes collected and reported to the taxing agencies, whether it’s the retailer or the company facilitating the sale.
It is imperative that companies keep a record of how each sale is taxed and who has collected and/or reported the sales tax. This enables transparency into potential liabilities, which, by extension, allows companies to prepare for the payment of such liabilities.
The complexities and far-reaching effects of the Wayfair decision for technology companies cannot be understated. Sales and use tax exposure is just the tip of the iceberg. From state income tax to financial reporting, Wayfair has unleashed a formidable amount of change to the most basic tax operations of your business. If your company is in the business of making sales, you should be assessing how Wayfair compliance has altered your total tax liability.
Wayfair Case Study
If you are in the business of making retail sales of tangible property or taxable services, it is more likely than not that you will need to charge, collect and remit sales taxes. For businesses that have not been collecting sales/use taxes on their out-of-state transactions, their financial statements should reflect this liability and, if audited by state tax authorities, there may be a significant cash outlay.
Case Study: Economic Nexus of a Software as a Service (SaaS) Company
A SaaS company was collecting sales and use taxes only for sales made to in-state customers, even though it had customers located nationwide. When the organization’s owners decided to sell the entire business, the buyers discovered the company’s failure to collect taxes on remote sales during their due diligence process and determined that there would be a significant successor liability related to these uncollected taxes. Once the sales tax liability was discovered, the buyers sought a considerable purchase price reduction for the acquisition of the company, which meant the seller had to sustain an economic loss they had not anticipated. Ultimately, the parties agreed on a plan to remediate the exposure in non-filing states through participation in state Voluntary Disclosure Programs, including an escrow that would allow the buyer to resolve the unpaid sales tax issue occurring under the seller’s watch. The buyer then spent the next year working with its outside sales tax professionals to negotiate and finalize the terms of VDAs.