Oct 17, 201809:01 PMExit Stage Right
with Martha Sullivan
The Wayfair decision — Can sales tax break a deal?
(page 1 of 2)
The value of a business is in the eyes of the beholder — the buyer. It reflects the perception of how much reward she or he will get for the risk that they are taking on. Tax exposure is certainly a risk every buyer should understand and analyze because it can be significant. On June 21, the Supreme Court upped the ante related to tax risk, particularly sales tax risk.
In the court’s South Dakota v. Wayfair Inc. decision, the justices threw away the old rules on what obligation a merchant has to collect and remit sales tax in any given state.
As background, under the Supreme Court’s 1992 Quill Corp v. North Dakota case, the litmus test for sales tax was whether the merchant had a physical presence in a state. As a merchant, you had to have a store, warehouse/goods, employees, and other situations in which your people or property stepped into the state to do business. If you did any of these types of activities, you were considered to have “nexus” in that state. Currently, 45 states collect state-level sales tax with rates ranging from 2.9 percent (Colorado) to 7.25 percent (California). Many states also have local sales tax at the county and/or municipal level. The merchant’s physical presence, not the customers’ location, has been the guidepost for state and local sales tax requirements since 1992.
Physical nexus was logical then. In Quill, there was no way to know how retail commerce would evolve from 1992 to today. Public access to the World Wide Web was less than a year old at that time. Today, almost all retailers have a website to broaden their sales beyond their physical footprint. By selling online, merchants extend their economic reach. The concept of economic reach drives the Wayfair decision.
At least 30 states have enacted internet sales tax laws given the growth in e-commerce. If you sell into one of these states, you likely have click-through or economic nexus. You’re expected to charge, collect, and remit such sales tax to that state. However, even with such laws on their books, enforcement could be contentious because of the Quill precedent. Wayfair resets the table. There’s no longer a question of whether these states’ laws are enforceable based on legal theory and precedence.
Online retailers have been wrestling to navigate sales tax compliance for quite a while. There’s no uniformity among the states’ laws. Thresholds on revenue and/or the number of transactions that trigger a liability vary by state. Wayfair doesn’t address uniformity. In oversimplified terms, it only says the rules have changed and that states can go for it — and the states are going for it. At the beginning of October, 10 more state internet sales tax laws went into effect. It wouldn’t surprise me if eventually all the sales tax states update their laws to cover all online retail commerce.
So, what does this have to do with the sale of a business and risk in the deal?
Consider this scenario: A business we’ll call iSellStuff.com sells exclusively through its website. iSellStuff is physically located in a single state but has a nationwide customer base. About 5 percent of its $10 million in sales is in its home state — the only state in which it currently collects and remits sales tax. Under Quill, this was all that was theoretically needed. Under Wayfair, not so much.
Pre-Wayfair, iSellStuff had an annual sales tax liability of about $25,000. Since it charged the customer for sales tax and then paid that to the state, iSellStuff complied and the money didn’t come out of its pocket. Under Wayfair, assuming all sales were in states that have an internet sales tax, that exposure goes to $500,000, a difference of $475,000 per year. The owner of iSellStuff doesn’t read this blog and isn’t aware that he’s operating in a new world. He continues only collecting and remitting sales tax from his home-state customers.
Three years from now, he strikes a deal to sell the company for $5 million. In due diligence, this sales tax issue is detected. It’s just a matter of time before states come looking for that money. Only he won’t have it and can’t go back to customers to get it. Under the three-year sales tax statute of limitations, the total uncollected, unremitted sales tax liability is at least $1.425 million before penalties and interest. That’s 28% of the deal price.