How Does the Wayfair Decision Impact Private Equity?
Assessing what actions are needed after the US Supreme Court overturns the physical presence nexus standard
The US Supreme Court’s decision in South Dakota v. Wayfair, Inc. et al to overturn the physical presence nexus standard will require all taxpayers to determine new filing requirements. The decision has opened the door for states to assert an economic nexus standard that will create additional administrative burdens on many companies as well as additional tax exposure for those that do not properly address the issue.
For private equity funds, this means more scrutiny will be required for portfolio companies in both the acquisition and divestiture process with respect to sales and use taxes. As most private equity funds have experienced, many companies have not properly addressed their state nexus issues and sales and use tax inevitably becomes an issue during the due diligence process.
A short summary of Wayfair
On March 22, 2016, South Dakota enacted S.B. 106, requiring out-of-state sellers to collect and remit taxes when a seller annually delivers more than $100,000 of goods or services into the state or engages in 200 or more separate transactions for the delivery of goods or services. Armed with the new provision, the state filed an action against certain remote sellers that had no physical presence in South Dakota but met the economic nexus standard. Summary judgment was granted to the remote sellers on the premise that the US Supreme Court had previously required a physical presence test be applied in Quill Corp. v. North Dakota. The Wayfair case was ultimately heard by the US Supreme Court to determine if the physical presence test that was previously determined in Quill to be the law of the land should be reconsidered. The US Supreme Court ruled that the physical presence rule of Quill is unsound and incorrect and is overruled.
Many states already have laws in place that allow for economic nexus positions that require out-of-state sellers meeting specific thresholds to collect and remit sales taxes on taxable products and services sold within their borders. Most of the remaining states are preparing to pass similar legislation. Some states now require companies making taxable sales in their state to report those sales and notify customers of their use-tax obligation. Penalties for non-compliance can be significant.
If your portfolio company has taxable sales of products or services in states with economic nexus or reporting requirements, your management team must begin monitoring these sales to determine if certain thresholds are met. The portfolio companies will need processes in place to collect and remit sales tax to the state, or, in some cases, comply with the reporting requirements.
Action steps for all private equity groups
The identification of risk and related mitigation opportunities are summarized in the following two core areas:
Assess risk in current portfolio companies
- Encourage your portfolio company to register in states where it has nexus: If your portfolio company makes taxable sales in a state and meets nexus criteria, it needs to register. However, if prior exposure exists, your company should determine if past liabilities should be resolved prior to registering using a voluntary disclosure or amnesty program. Download Cherry Bekaert’s free charts listing states with economic nexus laws, reporting requirements and marketplace facilitator legislation by visiting the Knowledge Center on our website.
- Determine whether portfolio company’s sales are taxable in states where nexus exists: Even if economic nexus thresholds are met, no tax obligation will exist unless the products and services are taxable in the jurisdiction where the product or service is received. Unfortunately, taxability determinations vary by state and can become quite complex, especially in the technology industry.
- Help your portfolio company improve sales and use tax policies and procedures: Cherry Bekaert’s sales tax team can review your company’s processes and recommend ways to more easily meet sales tax obligations. Our team can assist from developing and documenting sound procedures to outsourcing the preparation of the sales tax returns to remove that burden from your management team.
- Review options for ongoing sales tax compliance: Once registered and collecting tax, your portfolio company is required to file sales and use tax returns. Multiple state registrations means filing multiple tax returns. Your company may benefit from outsourcing sales tax return filings.
Adjust due diligence approach on future acquisitions
Sales tax is often a headache and a key area of concern for many private equity groups during due diligence on prospective acquisitions. The recent change in law means reviewing potential risks for sales tax non-compliance is more important than ever. Consider these recommendations while appraising your target’s sales tax liabilities:
- Conduct a nexus review: Is your target company meeting its current sales tax obligations? Will a lack of focus on this area have a significantly negative impact on your ability to sell the company? A nexus review will identify potential exposure issues and determine if current sales tax obligations are being met.
- Review future exposure issues: How will your company be impacted by the new sales tax obligations? Is your staff trained to meet these obligations? Do they understand the taxability of their products and services? Can they monitor taxable sales, register with states and complete sales tax returns? If applicable, are exemption certificates valid?
Your private equity fund and portfolio companies are now facing new sales tax challenges due to the Wayfair decision. Make sure your current and target portfolio companies are ready to address these responsibilities while reducing financial risks to your private equity fund.