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How the Wayfair decision changed due diligence for private equity groups

February 28, 2020 / 5 min read

With the Wayfair decision, businesses selling across state lines face more sales tax obligations than ever before. Here’s how private equity groups can adapt due diligence procedures to uncover potential deal-breakers.

Private equity (PE) groups should be concerned about state tax liabilities before finalizing a potential deal and should strongly consider performing state and local tax due diligence prior to close. The June 21, 2018 Supreme Court’s decision in South Dakota v. Wayfair, Inc. enhanced the ability of states to require out-of-state businesses to collect and remit sales tax, and that change has in turn made the landscape of tax due diligence significantly more complex.

The ruling upheld a state law that required out-of-state businesses to collect and remit sales taxes based on “economic nexus,” a concept focused on the level of sales activity the taxpayer conducts in the state. South Dakota’s law imposed a collection requirement on out-of-state businesses, with no physical presence in the state, that had either $100,000 in sales or 200 separate transactions in the state during the year.

The varying rules and regulations make state tax compliance considerably more challenging and significantly increased the risk a buyer may inherit.

In the wake of the Wayfair ruling, almost every state that imposes a sales tax adopted some type of economic nexus requirement on out-of-state businesses, with no physical presence, that sell into its jurisdiction. However, not all of the states use South Dakota’s thresholds. States are aggressively expanding the economic nexus statutes to include income, franchise, and gross receipt taxes. The varying rules and regulations make state tax compliance considerably more challenging and significantly increased the risk a buyer may inherit related to historical state tax liabilities of a target.

Unknown state tax obligations are particularly troublesome in the deal space for several reasons, including:

Whether you’re a business owner looking to sell or a PE group considering an acquisition, it’s critical to assess a seller’s state tax obligations — both known and unknown — before you close a deal.

Avoiding PE buy-side deal-killers

On the buy side, PE groups should strongly consider state and local tax due diligence with a focus on economic nexus statutes, and they need to make sure the contracts include proper indemnification clauses for any unknown obligations that are found after the sale. Post-Wayfair buy-side due diligence should include:

Avoiding PE sell-side deal-killers

Sales tax — along with other state tax obligations that are uncovered during the tax due diligence process — can easily kill deals. On the sell side, business owners considering a sale as part of their exit strategy need to prepare themselves ahead of time in order to resolve issues before starting discussions with potential buyers. These preparations include:

Moving forward with Wayfair

The changes brought about by the Wayfair decision may make sales tax compliance and due diligence more complicated, but PE investors that work in this environment day-in and day-out know what it means to manage risk.

 The varying rules and regulations make state tax compliance considerably more challenging and significantly increased the risk a buyer may inherit.

If you want more information on how you can more effectively manage the new risks introduced by state economic nexus rules, please contact your Plante Moran advisor.

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