Winning as a seller: Prepare for tax impacts of sale
INSIGHT ARTICLE |
Given today’s frenzied deal making pace, sellers are able to command top dollar if they go into the sales process ready to hit the ground running, which includes preparing for the tax impacts of sale. Jennifer Wiskus, a partner in Mergers and Acquisitions (M&A) Tax Services for RSM, and John Wozniczka, a partner with RSM’s state and local tax group, discuss how sellers can ultimately garner the best price with the least amount of headaches.
Fugazy: How would you describe M&A processes today?
Wiskus: In many sell-side processes where investment banks are involved, the processes are moving very quickly. And because those processes are moving so fast, our sell-side clients really need to be prepared going into the process. We are talking to our clients about the impact of the sale structure on capital versus ordinary income much earlier in the process.
Sellers are thinking much earlier in the process about the tax benefits they are going to be passing on to a buyer, what is the value of such tax benefits, and what the positive impact is on the sale price. On the flip side, sellers are trying to avoid any tax issues that need to be remediated that may have a negative impact on the sales price and if any issues can be remediated to minimize any potential purchase price adjustment. If a seller needs to remediate any tax issues, planning ahead and starting the remediation well in advance of a sales process will help the sales process go more smoothly and can minimize any negative tax impact. The most frequent exposure we see requiring remediation is sales tax exposures, which can take several months to a year to fix with tax authorities depending on the complexity of the situation.
Wozniczka: Sell-side due diligence serves two purposes. First, it is a validation of the state of a company’s tax compliance processes—having a report indicating that everything is handled properly goes a long way in helping to ensure a smooth sales process. It adds value and speeds up the sales process. The other benefit is that it allows sellers to identify potential problems before they become major problems during that transaction process.
When a company conducts sell-side tax due diligence, the seller is giving itself the opportunity to understand and resolve any possible issues. Waiting until the due diligence process for a buyer to find tax issues can sometimes make a tax issue bigger than it is due to the inability to gather data in a short time frame and perform a thorough analysis.
Fugazy: How sped up has the sales process become and are sellers preparing earlier as a result?
Wiskus: How quickly deals move is based on many factors and that will also determine the timing of preparing of sale and the due diligence process. We are seeing more interest in preparing for sell-side transactions from a tax perspective and preparing sell-side tax diligence reports. Still, the interest in sell-side quality of earnings reports tends to be much greater than for sell-side tax diligence reports.
Sellers want to avoid deal fatigue and increase deal value, so it makes sense to do a quality of earnings report and sell-side tax reports, but it is not a one-size-fits-all approach. It depends on the seller and the complexity of the deal and the size of the deal. No matter what the deal dynamics are, generally the earlier you start preparing for sale the better.
Fugazy: How can tax issues affect the timing of a deal?
Wiskus: If the tax issues are complex, we have seen deals where it takes over a year to remediate issues and prepare for sale, especially if there are issues that the seller needs to work through with the IRS or work through state tax authorities. Simpler tax issues don’t take as much time to address.
The best thing to do if you are contemplating a sale is to take a pause and really think about your tax situation. Lots of sellers are busy running their businesses and don’t have excess capacity to go over every tax issue. Taking time prior to sale to work with an advisor to evaluate potential tax issues will allow sellers to weed out minor tax issues and address larger concerns. In many instances, after that initial evaluation there may be nothing to do and that allows sellers to confidently go into the sales process.
Wozniczka: If there are no issues you can get through sell-side due diligence relatively quickly. When you do run into issues, they do take time to sort out because you are dealing with a lot of transaction level detail. Resolving issues, especially on the sales and use tax side, do take time and may require contacting customers to get the necessary documentation to support certain exemption claims. Ideally six months would be enough time to identify issues and get them fixed if needed, but we have certainly done it in shorter time. That said, having a year to six months is ideal. Anytime there are multiple entities it tends to take longer.
Wiskus: I would also add that if you’re working with family-run business those sale processes go a little longer because these businesses just don’t go through as many transactions as a private equity seller would go through and their business is their heart and soul.
Fugazy: How has tax reform changed deal dynamics for sellers?
Wiskus: Tax reform has changed how sellers potentially negotiate to be paid for tax attributes, especially in a C corporation setting where the corporate tax rate has been reduced to 21 percent and net operating loss (NOL) carrybacks are no longer allowed. So if a NOL is generated in the year of sale due to transaction deductions, a seller now needs to negotiate with the buyer to obtain benefit for such a NOL and can’t carry back such NOL to obtain tax refunds, which was common prior to tax reform. As well as the taxation of non-US operations has significantly changed under tax reform and impacts deal structures so that is an area of continued focus.
Wozniczka: Tax reform will certainly come with its challenges given that states are still trying to catch up to the changes posed by the federal government. The states continue to respond to tax reform in various ways, and to some extent, are still waiting to understand how federal reform will ultimately impact state budgets – even more than a year later. Moreover, added complexity was created by the U.S. Supreme Court’s decision in South Dakota v. Wayfair, which overturned the long-standing "physical presence” nexus standard established through Quill v. North Dakota in 1992.
Since the decision in June of 2018, most of the states have adopted laws establishing sales and use tax nexus for remote businesses if certain sales or activity thresholds are exceeded. Accordingly, it is much easier for companies to have filing requirement in these states since nexus can now be established through economic activity. This is a monumental change because, historically, companies relied on having some kind of physical presence in a state in order to be subject to that state’s sales tax.
Companies that are not complying with these new sales tax filing requirements are going to have difficulty with the due diligence process. Typically, sales and use taxes are significant areas of exposure for a lot of companies, and if they’re not doing something about it now, it could result in a big surprise down the road.