Sales/use tax considerations in asset transactions.

From a Federal income tax standpoint, an asset purchase may be an attractive way to structure an acquisition or a useful step in a corporate reorganization plan. In most states, the Federal tax benefits of a step-up in the basis of assets purchased and consequent increases in future depreciation deductions are similarly recognized on state income/franchise tax returns (although unforeseen, and relatively minor, increases in alternative or additional state corporate taxes measured by net worth or tangible property may result).

What may be overlooked while Federal and state income tax benefits are being tabulated are the sales and use tax ramifications of an asset purchase, or "bulk sale." In most states, there are compliance procedures for notifying the state of a change in the ownership of a business. In many states any transfer of title to motor vehicles (and/or vessels or aircraft) calls for reregistration of the conveyances as well as an additional payment of sales tax at the time of registration. In some states a bulk sale is considered (or can be considered under certain circumstances) a sale at retail. In those states, that portion of the purchase price allocable to tangible personal property located in the same state may be subject to sales/use tax, barring the applicability of any specific exemptions.

Bulk sale notification

The notification requirements of the various states represent a classic example of the lack of uniformity in state tax administration. Indeed, in some states the term "bulk sale" is not mentioned at all in statute, regulation or administrative pronouncement. Instead, specific procedures are outlined for reporting a "substantial" change in ownership, the transfer of "all or substantially all" of a business's property or the "winding up, dissolution or liquidation" of a business; these procedures may apply in the event of an asset purchase.

In other states, a bulk sale is identified as a special type of transaction requiring specific actions by the seller and/or the purchaser. However, instructions for these actions may range from a single paragraph in the sales/use tax statute to several pages of detailed regulations.

In some states special forms must be completed to report a bulk sale, while other states fail to define a reporting requirement beyond "notification." Similarly, there is no uniformity as to when the required notification must be made. Deadlines can range from 15 days before a sale is completed to requirements that a final tax return be filed by the seller 30 days or more after the sale.

The goal of these notification requirements is to ensure that any amounts of tax (and penalties and interest) owed to a state by the seller are paid before the seller ceases business operations in that state. Indeed, in several states, notification is required even when one business location out of several ceases operations. Compliance with these notification requirements is encouraged in several ways.

In more than 330 states, the purchaser is required to withhold a sufficient amount of purchase proceeds to cover the seller's sales/use tax liabilities. The withholding continues until the seller can provide tax clearance documentation or, in some state, until the expiration of a specific period (usually 60 or 90 days) after a bulk sale notification is made.

In some of the states in which no withholding is required, no new sales/use tax registration or permit can be issued to the purchaser until any sales/use tax problems of the seller are resolved.

Finally, in the states with notification and/or withholding requirements, purchasers ignore those requirements at their own peril. Laws in those states can hold the purchaser liable for some or all of the amounts owed to the state by he seller.

Many of these statutory requirements are quite old, dating from the inception of the sales/use tax in the various states. They were intended to prevent retailers from selling out and absconding with state monies. While the drafters of these provisions obviously did not contemplate modern asset purchases involving nonretail businesses, the statutes nonetheless apply to such transactions.

In modern transactions, in which final terms and conditions may be negotiated right up until the consummation of a deal, compliance with state deadlines for advanced notification of a bulk sale may not be possible. In such situations, a prudent purchaser will endeavor to avoid post-transaction tax problems by escrowing a sufficient portion of the purchase price to cover any state and local tax contingencies. Alternatively, the purchase agreement should contain an indemnification provision protecting the purchaser from any unforeseen sale/use tax consequences of the asset purchase.

Application of sales/use tax

to asset purchases

In most states, the sale of all (or substantially all) of a business's assets (other than motor vehicles, vessels and aircraft) is exempt from sales/use tax. Asset transactions usually qualify as "casual," "isolated" or "occasional" sales, specifically exempted from sales/use tax.

Yet, even in states that grant this type of exemption, there may be limitations. In some states (e.g., Arizona, Missouri, South Carolina) the exemption is available only when the taxpayer's "entire" business is sold. Therefore, problems may result when the assets of only one of a taxpayer's divisions, or the assets at some (but not all) of a taxpayer's locations are sold. Other states impose a similar restriction limiting the exemption to the sale of "all or substantially all" of a taxpayer's assets.

Some statutes make reference to a "single" transaction, while some states may specify that sales are "isolated" only if there are no more than two (e.g., Florida, Iowa, Kentucky), three (e.g., Virginia) or four (e.g., New Jersey, West Virginia) dispositions of assets during a 12-month period. Minnesota requires that an asset transaction be completed in 12 months, while Ohio's "casual" sale exemption applies to property "previously subject to the state's taxing jurisdiction."

Beyond these kinds of state-by-state peculiarities, Colorado, Maryland, New York and Oklahoma do not provide any kind of exemption that would apply to a bulk sale of business assets. In California, Nevada, Washington and Wisconsin, an asset sale will not qualify for treatment as a casual, isolated or occasional sale if the seller holds, or is required to hold, a permit or registration for sales/use tax purposes.

In states where a seller's permit or an "entire business" requirement jeopardizes the exempt nature of an asset transaction, it may be possible to plan around sales/use tax exposure. Creating a new subsidiary corporation solely to hold the assets for sale may be one way to avoid such exposure.

Many states exempt transfers of tangible personal property in exchange for all of the stock of a new corporation, as well as transfers of property made pursuant to statutory mergers, consolidations or liquidations. A corporation created solely to hold and subsequently sell a parent's tangible property in an asset sale should not be required to hold a seller's permit in most jurisdictions. Presumably the disposition of those assets would constitute the sale of the new subsidiary's "entire" business.

In certain situations, an even simpler solution may be appropriate. Many times, companies that sell property that becomes a component of another company's product, or are solely purveyors of services, hold sellers' permits when they are not required to do so. (These permits are usually held so that the company can remit appropriate use tax on its purchases.) In contemplation of an asset transaction, it may be possible to surrender an unnecessary permit and ensure eligibility for a casual sale exemption.

If neither of these strategies is appropriate, or property is located in one of the states that taxes bulk sales, sale/use tax can sometimes be minimized through an appropriate, detailed allocation of purchase price of the various assets purchased. Most states have sales/use tax exemptions for machinery and equipment used directly in manufacturing, processing, etc. In some states, tools and supplies used in manufacturing are also exempt. Inventories and material that become part of goods for sale should qualify for resale exemptions. As a result, purchase amounts allocated to these kinds of assets should not be subject to sales/use tax.

Conclusion

In asset transactions, it is essential that both the buyer and seller are aware of the sales/use tax notification and compliance requirements in each state in which property is located. Failure to consider these provisions can lead to problems long after the sale is ostensibly complete.

Similarly, the precise circumstances under which an asset transaction is exempt from sales/use tax can vary greatly from jurisdiction to jurisdiction. By paying proper attention to detail, pitfalls can be avoided and planning opportunities may exist for minimizing or eliminating sales/use tax.