Beware the Sales Tax
Required Reading for Attorneys Advising in Business Acquisitions
Article Date: Thursday, June 28, 2012
Written By: Zachary F. Lamb
An attorney who advises clients in business acquisitions should always require the seller to provide a Certificate of Good Standing issued by the North Carolina Department of Revenue (“NCDOR”) or else be ready to contact his or her malpractice insurer. Without the Certificate, the NCDOR can seek to recover any sales or use tax liability of the seller directly from the buyer, which will undoubtedly result in the buyer making an angry call to the buyer’s attorney.
NCGS §105-164.38(a) provides that the sales tax “is a lien upon all personal property of any person” engaging in a business subject to the tax “who stops engaging in the business by transferring the business, transferring the stock of goods of the business, or going out of business.”
Section 105-164.38(b) provides that “any person to whom the business or the stock of goods was transferred must withhold from the consideration paid for the business or stock of goods an amount sufficient to cover the taxes due until the person selling the business or stock of goods produces a statement from the Secretary showing that the taxes have been paid or that no taxes are due.” That subsection goes on to provide that if the taxes remain unpaid after 30 days from the date of the transfer, “the buyer is personally liable for the unpaid taxes to the extent of the greater of the following (1) the consideration paid by the buyer for the business or stock of goods; or (2) the fair market value of the business or the stock of goods.”
Pursuant to section 105-164.38(c), the statute of limitations for the NCDOR to seek to assess the buyer for the seller’s unpaid tax liability expires one year after the end of the period during which the NCDOR could seek to assess the tax against the seller. Under section 105-241.8(a), the NCDOR generally has three years from the date a return is filed to seek to assess the taxes against the seller (i.e. to assess a liability greater than that shown on the return). If the seller never files a return or files a fraudulent return, the period for the NCDOR to make an assessment is never closed.
Common Factual Scenarios
Stock Purchases: When a buyer acquires a business through a stock purchase whereby the buyer simply becomes the new owner of an ongoing entity, it should come as no surprise that the ongoing entity remains liable for its tax liabilities existing prior to the date the transaction occurs. This treatment holds true regardless of whether the ongoing entity is a corporation, limited liability company or partnership.
Asset Purchases: Typically, a buyer prefers to acquire a business through an asset purchase rather than a stock purchase because the former typically provides more favorable tax treatment to the buyer (e.g. a new basis against which to depreciate) as well as some separateness from unknown liabilities associated with the selling entity. However, the statutes referenced above allow the NCDOR to pursue the buyer for any outstanding sales tax liability of the seller, notwithstanding that buyer is operating the business in a new entity. Moreover, if the buyer financed the transaction and the lender did not do its due diligence by requiring a Certificate of Good Standing to be produced by the seller, the lender will find itself behind the NCDOR in terms of creditor priority with respect to any personal property purchased due to the NCDOR’s tax lien. Such a situation would likely violate terms in the financing agreement and, if personal guarantees are present, subject the principals in the buyer to personal liability.
In light of the foregoing, an attorney representing a buyer should always require the seller to deliver a Certificate of Good Standing issued by the NCDOR confirming that the seller is current with its sales and use tax obligations. If the seller is not current with said obligations, the attorney should involve the NCDOR before the sale closes to determine the amount of the liability and ensure that sufficient funds are withheld from the purchase price to satisfy that liability.
Unfortunately, some transactions close without any consideration of potential liability stemming from the rules described above. If, after a deal has closed, an attorney is approached by a buyer who failed to obtain a Certificate and whom the NCDOR is now seeking to collect the seller’s unpaid taxes, the attorney should consider the following defensive measures:
1. Recovery from Seller. Initially, the seller’s financial condition should be evaluated to determine whether the seller is capable of paying the taxes. However, if the NCDOR is pursuing the buyer, this typically means the seller has no assets from which to collect, making any warranties or indemnity language in the purchase agreement essentially worthless.
2. Statutes of Limitations. The buyer’s attorney should consider
whether the NCDOR has missed the time in which it can seek to collect from the buyer. With the advancement of technology, the The buyer’s attorney should consider whether the NCDOR has missed the time in which it can seek to collect from the buyer. With the advancement of technology, the NCDOR has become increasingly adept at ensuring that it does not make an untimely assessment, but the issue should nevertheless be considered.
3. Limiting Exposure. The NCDOR is only allowed to recover against the buyer the greater of (a) the amount of consideration the buyer paid for the assets, or (b) the fair market value of the assets acquired in the transaction. If the seller’s tax liability is high, this limitation may place a ceiling on the buyer’s liability. Also, if in the purchase transaction the amount paid by the buyer covered items other than assets (e.g. the seller’s promise not to compete), the consideration paid for those items should not increase the buyer’s liability. Ultimately, the purchase agreement is the best evidence of the allocation of the purchase price.
Personal Liability for Principals of the Buyer?
Section 105-242.22(b) authorizes the NCDOR to pursue certain principals of an entity that fails to satisfy various tax liabilities, including sales and use taxes. This statute is commonly referred to as the Trust Fund Recovery Penalty. While the author is unaware of any cases in which the NCDOR has attempted to use the Trust Fund Recovery Penalty to pursue principals of a buyer for a seller’s unsatisfied sales tax liability, a strict reading of the statute suggests that such an action would be permissible, particularly with respect to a stock purchase transaction where the seller had collected sales tax and failed to remit it to the State. It is the author’s opinion that such an action would be contrary to the intent of the Trust Fund Recovery Penalty and ultimately would be unsuccessful. Nevertheless, the specter of such an action is one more reason that a buyer’s attorney should always require the seller to produce a Certificate of Good Standing.
Due to the risk that a buyer in a business asset acquisition transaction could be held liable for any outstanding sales and use tax liability of the seller, the buyer’s attorney should always demand that the seller provide a Certificate of Good Standing issued by the NCDOR certifying that the seller has no such outstanding liability. •
Zachary F. Lamb is a shareholder of the law firm Patla, Straus, Robinson & Moore, P.A. in Asheville.
This article originally appeared in the May 2012 issue of Tax Assessments, published by the NCBA’s Tax Law Section.
Views and opinions expressed in articles published herein are the authors' only and are not to be attributed to this newsletter, the section, or the NCBA unless expressly stated. Authors are responsible for the accuracy of all citations and quotations.