The Supreme Court released its decision on the landmark sales tax case, South Dakota v. Wayfair in June 2018. The Court overturned the “physical presence” standard that previously determined when businesses had sales tax obligations. The decision held that the correct standard for determining the constitutionality of sales tax in a state is whether the tax applies to an activity with “substantial nexus” within the taxing state.
As a result, states are now allowed to include remote sales as criteria for creating substantial nexus, even if a business has no form of physical presence in a state. By merely having sales into a state, economic nexus can now be created.State officials nationwide have since implemented economic nexus regulations. Most are following some form of South Dakota’s economic nexus benchmarks of only requiring compliance from businesses with more than $100,000 or 200 transactions into a state in a calendar year.
Over the past several years, states have expanded their ability to tax remote sellers through economic and marketplace nexus rules. As a result, sales tax awareness has increased in the private equity world and worked its way to the top of the due diligence list.
In fact, the enforcement dates for many states began as early as July 1, 2018, resulting in any deal currently in the pipeline potentially facing significant sales tax exposure that may affect your ASC 452 accrual – and as a result, directly impacting EBIDTA.
Many professionals are confused and have assumed that Wayfair only applies to e-commerce transactions. However, this is not the case. States have broadly defined remote sellers and have cast a wide net.
For example, Nebraska defines remote sellers as “retailers that do not have a physical presence in Nebraska, but sales to purchasers in Nebraska,” and Maryland defines a remote seller as anyone who “sells or delivers tangible personal property or a taxable service for use in Maryland.”
Buy-side investors should have two major concerns on deals currently in the pipeline. Even though the historical exposure may be minimal due to the recentness of the rule change, some states have requirements that predate the Wayfair case, which are now validated. In addition, since 2019, most states have imposed economic nexus. And for every month that passes by, historical liabilities increase for businesses.
For example, Massachusetts has issued guidance about its economic nexus rules in place since 2017. They have not stated that there is a future enforcement date, and they may assert that sales tax is due since the inception of the bill. Before Wayfair, many companies have taken an aggressive position with states that enacted an economic nexus rule. Those aggressive positions can become future liabilities.
Second, the buyer has to be prepared to collect sales tax in new states immediately. For example, a typical software company with revenue of $50M and physical presence in three states may have been previously collecting and remitting sales tax in three states. However, an economic nexus evaluation report on those sales may show that the company has had sales tax filing requirements in 20 other states.
Needless to say, buy-side investors need to be prepared in the post-Wayfair world. Sales tax liabilities will grow quickly if proper systems are not in place. These costs will impact the bottom line, and in most states, the liabilities can be attached to owners and officers of the company.
Purchase agreements need to include strong language to protect the buyer. In some cases, we see buyers passing the cost of future compliance to the seller, including the cost of consultants to correct non-compliance matters. This same information needs to be adequately communicated to management, so expectations are understood on the future cost of sales tax compliance.
For businesses, it might be appropriate to explore new compliance strategies, a sales tax compliance software solution, or, in certain cases, a Voluntary Disclosure Agreement to minimize potential penalties and interest of past due sales tax.
Companies must prepare to collect and remit sales tax in any state with sales over $100,000 or sales more than 200 transactions. For many companies that have only been collecting sales tax in two or three states, this will mean considering new tax compliance software, making the decision on the taxability of their products in these other states, and deciding whether to train staff internally or outsource. Companies should begin this discussion with their tax professionals immediately.
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