Haynes and Boone, LLP
  November 30, 2012 - United States of America

DealThink: As Always – State Taxes Lurk as a Trap
  by Kenneth K. Bezozo, Lauren Waite

You are general counsel of a publicly traded medical device company that has begun the diligence process on your company’s target, a publicly held x-ray and CT scan component manufacturer. The target is a Delaware corporation based in California, with additional manufacturing facilities in Utah and Kentucky; within the past three years, it has sold two mothballed manufacturing facilities. It sends salespeople to 15 different states, but due to its Internet presence, it ships components worldwide. It also provides support services for its component parts within the continental U.S.

The tax partner at your company’s outside counsel has assisted you with the following tax-related diligence questions.

In what states should the target have been paying taxes if it has operations in only 3 states, is incorporated in Delaware, ships worldwide and sends sales people to 15 states?

The Key Issue is Nexus. When a company has nexus with a state, it generally has one or more tax obligations in that state. Nexus can arise from a variety of different factors, including the place of incorporation or a place where a company is doing business. Nexus also arises in states where a company sends salespersons or provides support services with respect to its products – though it depends on how the support services are provided. Some general rules for when a company has nexus with a state are:

What happens if the diligence uncovers that the target has not been paying properly its state taxes?

Avoiding Successor Liability. Assuming that the target has tax obligations in 21 states (the state of incorporation, the 3 states where it has facilities, the 2 states where it previously had facilities, and the 15 states where its salespersons operate) and is only paying tax in three states, the next issue is how your company, as purchaser, avoids being liable for the unpaid taxes of the target. The answer depends in part on the type of transaction.

Asset Purchases. If your company is purchasing the assets of the target (versus its stock), almost all states impose successor liability despite the fact that the purchaser is not acquiring the entity, but only the entity’s assets. Generally, successor liability can be avoided by obtaining a tax clearance certificate from each state (or a “certificate of no tax due”) which if granted prevents the state from asserting liability against the company for the target’s unpaid taxes. But be aware that in the process of requesting this state tax clearance, the state could assert that the target has unpaid tax liability in which case the purchaser is required to withhold and pay over to the state these unpaid tax liabilities. In other states, the procedure involves filing a bulk sales notice where the seller and purchaser notify the state of the impending purchase and provide certain documentation relating to the transaction. There are often strict time periods in which requests for tax clearance or bulk sale filings must be made. If the requisite certificate or filing is not made within the correct time period, the purchaser likely will have successor liability for the target’s unpaid state taxes.

Stock Purchases and Mergers. If your company is purchasing the stock of the target or merging with the target, your company will inherit all of the entity’s liabilities, including tax obligations. In general, purchasers in such a situation protect themselves through contractual provisions in the stock purchase agreement (i.e., escrows, representations and warranties, etc.).

In addition, the target currently gets a tax break because it built its newest plant in a depressed economic area in Kentucky. Could it lose that tax break in the event of a change of control?

Potential Loss of Tax Break. State and local laws and ordinances determine whether a change of control would result in the target losing its tax break in Kentucky. Additional diligence will be necessary to determine whether the tax break will either flow to your company, as the transferee, or be lost.

If you have any questions, please contact one of the following attorneys:

Brian D. Barnard
817.347.6605
[email protected]

 

Ricardo Garcia-Moreno
713.547.2208
[email protected]

William R. Hays, III
214.651.5561
[email protected]

 

William B. Nelson
713.547.2084
[email protected]

 

Janice V. Sharry
214.651.5562
[email protected]

 

W. Scott Wallace
214.651.5587
[email protected]

 

 

Jennifer T. Wisinski
214.651.5330
[email protected]





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