October 14/21, 2019: Volume 35/Issue 8
By Roman Basi
The recent Supreme Court decision (South Dakota v. Wayfair, Inc.) has dramatically impacted online retailers and increased possible successor liability risks in terms of merger and acquisition transactions.
Prior to the Wayfair ruling, the “physical presence” standard set out in Bellas Hess and Quill controlled online retailers’ necessity to pay South Dakota sales tax. The physical presence rule allowed out-of-state retailers who sell their products or services online to avoid the state’s sales and use taxes due to a lack of a brick-and-mortar business in the state. However, under the South Dakota Statute affirmed by the Supreme Court, online retailers are now required to pay South Dakota sales tax if their business has a “substantial nexus” with the state. This is reached when the retailer has sold more than $100,000 in in-state sales or completed 200-plus transactions in the state on an annual basis.
Following the Wayfair decision, over half of the states have developed and are implementing very similar requirements for out-of-state retailers. The Supreme Court found the physical presence standard not only incentivized the avoidance of state sales tax, but cost states an average of $8 billion-$33 billion per year in taxes. The physical presence standard is being phased out due to modern technological advances providing online retailers with the ability to reach virtually any U.S. consumer, and avoidance of states’ sales tax has become a multibillion-dollar issue.
It’s important to understand the sales and use tax liabilities in the context of buying or selling a business involved in online retail. This increasing development of case law has led to more exceptions to the rule of buyer non-liability. The ABA published a memorandum in January 2018 on successor liabilities in an asset transaction that has greatly increased its relevance in light of the Wayfair decision. In the memorandum, there are four exceptions of successor liabilities mentioned: (1) the buyer (successor) assumes the seller’s liabilities expressly or impliedly; (2) the transaction in substance constitutes a merger or consolidation of the buyer and seller (de facto merger); (3) the buyer is “a mere continuation” of the seller; and (4) the intent of the transaction is to defraud seller’s creditors. The most common of the four exceptions is the de facto merger. This exception is particularly influential if the transaction involves a continuity of management, general business operation and equity ownership, assumption of seller’s ordinary course business liabilities, physical location and seller’s dissolution following the sale.
The question becomes: how do the successor liability standards affect the buyer of a business that has online retail sales? If an online retailer does not follow the varying state-by-state requirements, it could result in a failure of sales and use tax payments or payments of the incorrect amount. This may result in unforeseen liabilities when a creditor comes seeking repayment. The best way to avoid any potential successor liability issues is with vigilant due diligence and strategic pre-transactional planning focused on the above-mentioned risk factors.
A strong M&A team will greatly help limit any potential stress during a transaction that may result in a buyer withdrawing their interest due to successor liability. Due diligence focusing on specific state requirements regarding payment of sales taxes and the elimination of state tax liabilities prior to closing is key.
Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners. For more information, please visit taxplanning.com.