Greg Falk EXECUTIVE SUMMARY PROFESSIONAL AFFILIATIONS EDUCATION

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2 Greg Falk Transaction Advisory Services Principal JD, LLM BDO New York - Park Avenue Office gfalk@bdo.com EXECUTIVE SUMMARY Greg has more than 25 years of experience providing clients with tax structuring and due diligence advice in connection with domestic and cross-border mergers and acquisitions. Although he has worked across many industries, his primary focus areas include financial services, media and entertainment, consumer and industrial products, technology, and infrastructure. His clients include both major corporations and private equity funds. Greg joined BDO in 2015 from KPMG. He joined KPMG in 2002 as leader of the Northeast M&A practice. He became National Leader in Prior to KPMG, he spent 14 years (10 as a principal) with PwC in the M&A tax practice. Before that he practiced law with the Boston firm of Goldstein & Manello where he became a partner in Greg began his career with the Internal Revenue Service s national office in Washington, D.C., where he specialized in corporate transactions. PROFESSIONAL AFFILIATIONS American Bar Association, Tax Section Massachusetts Board of Bar Overseers EDUCATION LL.M. (Taxation), Georgetown University Law Center J.D., Western New England University School of Law A.B., Economics, University of California, Berkeley

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6 Tax Due Diligence in Business Transactions Michael Kliegman, Esq., Akin Gump Strauss Hauer & Feld LLP Greg Falk, Esq., BDO USA, LLP Thursday October 6, 2016

7 Topics Importance of tax due diligence Planning tax due diligence Scope Typical procedures Objectives Common tax issues/focus areas Common tax structuring considerations

8 Importance of Tax Due Diligence Depending on the transaction structure, Buyer may inherit the existing tax liabilities and exposures of the Target Consider whether current taxes been paid and if adequate reserves have been accrued for exposures Most buyers prefer not to place sole reliance on contractual indemnities Effective tax rate adjustments identified as a result of due diligence procedures can have a material impact on valuation Cash flows associated with taxes affect valuation and financing decisions, particularly for PEIs Non-income taxes impacting EBITDA Tax contingency reserve items Material timing differences Depreciation/amortization of tax basis step-up Findings from due diligence can be important to implementing appropriate transaction structure and post-transaction planning

9 Planning Tax Due Diligence

10 Planning Tax Due Diligence Scope Type of transaction Asset versus Stock Type of Target entity C corporation v. S corporation v. Partnership/LLC Geography U.S. versus Foreign Consider transaction size and tax sophistication of client Tax structure and planning considerations The scope should always be determined by our client. Our clients often look to us for recommendations

11 Scope Asset purchase Generally requires less tax due diligence Allows buyer to purchase specific assets generally free from contingent liabilities, including most taxes Some exceptions exist, including sales and other transfer taxes - always consider state rules before providing advice More focus on structuring and tax planning Enhanced flexibility to implement optimal transaction structure Evaluate impact of tax basis step-up and analyze estimated cash flow impact of tax depreciation and amortization Consider cash requirements of potential transaction taxes Less attention paid to contingent liabilities Less attention paid to old accounting methods and tax attributes reduces risk of phantom or deferred income

12 Scope Stock purchase Typically we do more extensive tax due diligence in a stock purchase Buyer inherits all of Target s tax attributes and liabilities, including potential exposures for prior periods Seller s contractual agreement to pay any pre-closing taxes does not change the fact that the Target remains primarily liable To be made whole, Buyer must be able to enforce the provisions of the contract and Seller must be able to pay Stock purchases can be imbedded in asset purchases. For example, Acquirer purchases assets of a business where one of the assets includes the stock of a foreign subsidiary Target has joint and several liability for all pre-closing periods it was a member of a consolidated group This type of liability is almost always covered by a seller tax indemnity Very difficult to perform due diligence most sellers will not allow access to the consolidated group tax information outside of the Target subsidiary Section 338(h)(10) elections do not eliminate joint and several liability of Target subsidiaries

13 Scope Type of entity considerations C (regular) corporation Generally, all tax risks come with Target in a stock purchase S Corporation Same as above, but S corporation is not normally subject to income taxes so diligence is more limited and focused Consider validity of S corporation election and potential built-in gains tax Diligence still needed on non-income taxes such as sales tax, payroll and property tax Partnerships and LLCs (other than those electing corporate status) Similar to S corporations, not subject to income taxes so diligence is generally focused on non-income taxes Also look at tax basis considerations Due Diligence and AICPA Checklists should be used regardless of scope

14 Scope Sample Partnership Checklist Items Consider whether a check-the box election was properly made or should have been made Note the regulation covering the requirements to file foreign partnership returns (Reg (a)-1) If the taxpayer is a limited liability company, obtain a copy of the operating agreement and document the status as a partnership If the partnership has been examined by the IRS, state or local taxing authority: Obtain copies of the revenue agent s reports Obtain copies of all correspondence with the IRS or state taxing authority impacting the period covered by the predetermined scope.

15 Sample Partnership Checklist Items (continued) Review schedules for federal (regular tax, AMT, and ACE) and state carryover items, such as: Prior years deferred deductions Installment sales - consider applicable tax rates for various components of gain Changes in accounting methods requiring 481 adjustments Partnership inside basis (assets) and outside basis (interests) Determine if the partnership agreement complies with the 704 Regulations Determine that accounting methods used are comparable to the preceding year unless changes are approved or required. (See instructions to Form 3115 and most recent Revenue Procedures for a list of approved automatic changes.) (Rev. Proc )

16 Sample Partnership Checklist Items (continued) If the partnership is on the cash basis, determine if the accrual basis is required Determine if there has been a change in the partnership s ownership and/or a technical termination during the year. Note that electing large partnerships do not terminate as result of a transfer of 40% or more of the partnership interests. Determine whether a transfer of partnership interests qualifies as a sale or exchange. If a technical termination of the partnership occurred, consider the effect on partnership elections, the basis of partnership property, depreciation methods, potential credit recapture, ability to deduct unamortized costs and the need to file short period returns ( 708).

17 Sample Partnership Checklist Items (continued) If there were any sales or exchanges of partnership interests, partner deaths, or partnership distributions during the current year, determine if a 754 election was made or should have been made (or has been revoked). Consider mandatory basis adjustments for transfers that involved a substantial built-in loss Note that if the Partnership is a partner in another Partnership, a 754 election is necessary at both tiers

18 Sample Partnership Checklist Items (continued) For acquisitions that do not result in technical terminations, determine if the partnership has selected an allowable fiscal tax year other than the required year. Determine that Form 8716 has been timely filed and that required payments (Form 8752) have been made. Verify that a copy of Form 8716 was attached to Form 1065 for the first taxable year for which the election is made. Determine if the partnership has restructured debt. Review for possible discharge of indebtedness income Determine if thee has been a significant modification (Reg (a)) of the old debt which would constitute a taxable exchange of old debt for new debt. If the partnership has discharge of indebtedness income, consider the possible exceptions to inclusion of income at the partner level if it affects an existing partner (PEI).

19 Sample Partnership Checklist Items (continued) Determine if the partnership is eligible for tax credits going forward such as: Foreign tax credit Investment credit Credit for increasing research activities Inquire if foreign financial accounts exist (Form TD F ) Consider filing information returns relating to ownership in foreign partnerships (Form 8865) Consider filing information returns relating to ownership in controlled foreign corporations (Form 5471) Consider providing information to partner(s) for filing Form 926 for a transfer of property to a foreign corporation

20 Sample Partnership Checklist Items (continued) If a partner (PEI) is receiving an interest in exchange for services rendered, advise the partnership how to properly account for the exchange. (Rev. Proc , Rev. Proc , and Notice ) Determine if 409A deferred compensation applies to compensation arrangements. Information returns: Inquire whether the partnership has filed all required information returns Forms 1098, 1099, and 1042 and whether the value of the personal use of employer property, expense reimbursements under non-accountable plans and 401(k) deferred compensation information and nonqualified deferred compensation information have been included in its employees Form W-2 or Forms Consider whether worker classification is proper (i.e., employee vs. independent contractor).

21 S Corporation Checklist Review permanent file, prior year returns, memos, workpapers, carryovers and correspondence files. If the S corporation has been examined by the Internal Revenue Service, state or local taxing authority: Obtain copies of the revenue agent s reports Determine that the agent s adjustments have been entered on the S corporation s records and appropriate carryover workpapers. If the agent s adjustments affect income tax returns of years other than those audited, or the corresponding federal or state returns for the same year, consider filing amended returns. Inquire whether the S corporation has informed the shareholders of examination by the IRS or state agency to avoid post-acquisition surprises. Obtain copies of all correspondence with the IRS or state taxing authorities

22 S Corporation Checklist (continued) Election/revocation/termination of S status: Confirm that IRS (and state if applicable) approval of the election has been received and is in effect for the current year. Consider scheduling potential built-in gains at date of election. Consider requesting relief of an invalid election under 1362(f). Consider requesting relief for a late election under 1362(b)(5). (Rev. Proc , , and ) Events terminating S status: Determine that no disqualifying event has occurred related to excess number of shareholders, prohibited type of shareholder or issuance of a second class of stock. Consider changes regarding number of shareholders, types of shareholders and safe harbor debt

23 S Corporation Checklist (continued) Determine that termination is not triggered by excess passive income for three consecutive years if corporation has C corporation accumulated earnings and profits If the corporation owns a qualified Subchapter S subsidiary Verify Target has included all assets, liabilities, and items of income, deduction and credits of the QSub on the return Note new relief available to inadvertent invalid Subchapter S elections and terminations under 1362(f) If the corporation has selected an allowable fiscal tax year, determine that Form 8716 has been timely filed, and that required payments (Form 8752) have been made, if required. Verify that a copy of Form 8716 was attached to Form 1120S for the first taxable year for which the election is made, if required. If the corporation is on the cash basis, determine if the accrual basis was or will be required

24 S Corporation Checklist (continued) Review Board minutes Determine if Form TD F is needed to report foreign financial accounts Determine state and local tax filing requirements Recognition of S status Composite filing exposure on behalf of nonresident shareholders Consider if all listed and reportable transactions that needed to be disclosed on Form 8886 were properly disclosed. Note new penalties for failure to report.

25 S Corporation Checklist (continued) Consider anti-churning rules Tax on excess net passive income: Determine if passive investment income is greater than 25% of gross receipts and the S corporation has earnings and profits from any C years Tax on built-in gains applied to prior C corporations that filed S status election subsequent to 1986: Verify if 1374 tax was assessed and computed at the maximum corporate rate for the net recognized gains for the taxable years (not to exceed subchapter C taxable income as adjusted) on the disposition of assets

26 S Corporation Checklist (continued) Consider C corporation available carryovers Consider tax on LIFO recapture for C corporations electing S status Consider elections and statements Inquire if the required Forms 5500 have been filed for retirement plans Information returns: Inquire whether the S corporation has filed all required Forms 1098, 1099 and 1042 and whether the value of the personal use of employer property, expense reimbursements under nonaccountable plans, 401(k) deferred compensation information, and nonqualified deferred compensation information has been included in employees Form W-2 or Forms 1099 Consider worker classification Inquire if the taxpayer has complied with electronic filing requirements for Form 1099 and W-2 Inquire if nonqualified deferred compensation information has been included in employees W-2s or Form 1099

27 C Corporation Checklist For controversial or aggressive positions on the return: Has the client taken a controversial or aggressive tax position? Do all tax positions meet the substantial authority standard? Inquire about correspondence from taxing authorities, including revenue agents reports Has the taxpayer considered relevant tax elections and accounting method issues? Does the corporation meet any of the definitions of a personal service corporation (PSC)?

28 C Corporation Checklist (continued) Is the corporation a personal holding company (PHC)? Is the corporation subject to the passive activity loss rules or the at-risk rules? If the corporation uses the accrual method, has the recurring item exception method been adopted? [See IRC 461(h)(3) and Reg (d).] Has the corporation properly adopted LIFO?

29 C Corporation Checklist (continued) Carryovers and Carrybacks Have the following carryover items been considered? NOL and capital loss? Charitable contributions? Percentage depletion? Deferred gain from installment sales? Passive losses and credits? Section 465 (at risk) losses? Change of accounting method requiring Section 481 adjustment? Section 179 expense? General business, minimum tax, and foreign credits? Inventory adjustment resulting from UNICAP? Prior-year overpayment credited to the current year? If the corporation is a member of a controlled group, have tax bracket amounts been allocated among the group members?

30 C Corporation Checklist (continued) Has potential exposure to the accumulated earnings tax been calculated? Were payments for expenses to cash-basis related parties made prior to year-end? Have there been any shifts in ownership percentages? If so, have the potential ramification of any changes been considered (e.g., IRC Secs. 382 through 384)? If a consolidated tax return was filed, did the Target: Attach Form 851? Attach Form 1122? Review consolidated journal entries and determine that intercompany eliminations and restorations are calculated correctly? Attach election to allocate tax liability of group?

31 C Corporation Checklist (continued) Did the Target consider elections and statements such as: Election to expense or amortize organization costs? Election to expense or amortize business start-up costs? Cash vs. accrual method of accounting? 351 statement for transfers to controlled corporations? Method of valuation of inventory? Research and experimental costs? Exception from economic performance requirements for recurring items and the 3½ month rule? Consider applicable reporting requirements for the Target, including information reporting Forms 1099, for the following corporate liquidation and reorganization transactions: Reorganizations Liquidations Corporate separations Corporate acquisitions Corporate inversion transactions

32 C Corporation Checklist (continued) Determine whether there are any reportable transactions that needed to be disclosed on Form 8886 Reconcile net income per books to taxable income per return, including review of prior year s Schedule M-1 adjustments Did the Target file information returns related to ownership in foreign entities and disregarded entities Controlled foreign corporations (Form 5471) Foreign partnerships (Form 8865) Foreign disregarded entities (Form 8858) Transfer of property to a foreign corporation (Form 926) Consider filing requirements of foreign-owned U.S. corporations (Form 5472)

33 C Corporation Checklist (continued) Determine if Form TD F was needed to report foreign financial accounts Inquire if the required Forms 5500 have been filed for retirement plans Consider whether S and/or QSub elections were made to verify proper tax return filing

34 Typical Tax Due Diligence Procedures Read background materials Analyze relevant data room and supplemental information, including but not limited to material tax returns and reports from prior tax examinations Analyze income tax provision and related working papers and interview independent auditors regarding tax matters This may be done in connection with accounting team s review of audit working papers Interview target tax management and/or external tax advisers Interview other target management to the extent necessary to gain an understanding of operating or financial matters affecting tax liabilities Report on material findings Read and comment on the client s investment model Read and comment on the draft purchase agreement

35 Objectives What are we looking for when we do these things? Material tax exposures from prior periods Nature, amount, timing, likelihood and extent covered by reserves on the books Permanent differences Timing differences to the extent they materially affect cash flow or penalty exposure, particularly for private equity clients Developing of future problems, such as: Limitations on use of tax attributes (e.g., change of control limits on NOLs, overall foreign loss limits on foreign tax credits) Limitations on deductibility of interest expense from the acquisition Inadequate controls/accounting for taxes Information that will be useful in structuring the transaction and other tax planning, such as: Details of current legal entity structure Tax basis information

36 Common Tax Issues / Focus Areas

37 Income Taxes Common areas of income tax diligence focus Prior acquisition, disposition and restructuring history Other significant non-recurring transactions International allocation of income and expenses and international cash flows Between countries U.S. states Major tax accounting methods Executive compensation and employee benefits matters Private company costs Not an all-inclusive list!

38 Prior Acquisition, Disposition and Restructuring History Consider major M&A and reorganization activity of the target or its subsidiaries to assess tax risks and exposures Potential under-reported gains Tax basis impact Deduction of deal costs and change of control payments Existing limitations on use of tax attributes such as NOLs and credits Deductibility of acquisition indebtedness Implementation of tax planning strategies Evaluate existing tax indemnification provisions if buyer inherits historic tax liabilities

39 Other Significant Non-recurring Transactions Analyze tax reporting of other significant non-recurring transactions, such as: Refinancing Sale/leaseback transactions Relocations Asset write-downs Commencement of new business lines or geographic expansion Inquiries should consider potential for errors as well as explicitly tax-motivated transactions

40 International Transactions Consider allocation of income and expenses between jurisdictions and potential income tax rate arbitrage Consider international and U.S. state Analyze intercompany transactions from transfer pricing perspective and review related transfer pricing documentation Product sales Services Intangibles licensing Financing Consider U.S. Subpart F rules Inquire regarding nexus issues and no where sales for state income tax purposes Assess tax consequences of cross-border cash flows Evaluate use of foreign tax credits Consider withholding tax obligations Address deductibility of interest payments

41 Major Tax Accounting Methods Determine accounting methods used Consider issues common in the industry, particularly for specialized sectors Consult industry specialists Research material available Consider inventory of book/tax differences reflected in deferred tax analysis Analyze significant tax and book accounting method changes for aggressive tax reporting Assess calculations of and assumptions underlying material tax credits Purge methods with Section 338 or asset acquisition If possible, clean-up improper or unwanted tax accounting methods in pre-acquisition tax returns If not possible, determine effect of changing tax accounting method as soon as possible after the acquisition date

42 Major Tax Accounting Methods Taxation of various items of taxable income including advance payments, rebates and refunds Timing with respect to trade discounts given to vendors Deferral of sales revenue, advance payments for services and other items of taxable income Deductibility of disputed receivables Cash discounts to customers and vendors Deductions timing of various recurring and non-recurring items including reserves Deductibility of prepaid expenses Catalog/promotional costs Materials and supplies otherwise capitalized

43 Major Tax Accounting Methods Timing for self-insured medical deductions to expedite the deduction from when paid to when submitted or incurred Medical portion of workers compensation Timing of deduction with respect to Cooperative Advertising Timing with respect to accrued professional fees Software development costs Catch-up depreciation as a result of cost segregation studies Repairs and maintenance Timing with respect to deductibility of rotable spare parts Bad debt expenses Sales incentive/rebate reserves

44 Major Tax Accounting Methods Payroll taxes on deferred compensation Accrued bonuses Timing for the deduction of stock options Lien-date method for property taxes Transaction cost analysis Inventory UNICAP (Section 263A) Inventory reserves including inventory shrinkage estimates IPIC (Industry Price Index Computation) LIFO

45 Executive Compensation and Employee Benefits Matters Analyze executive compensation arrangements with emphasis on: Potential Section 280G golden parachute arrangements (prior or current transaction) Section 163(m) excessive compensation Section 409A considerations Proper payroll tax reporting Inquire regarding: Target payroll tax compliance process Payroll tax audits and/or penalty assessments Employee vs. independent contractor status Compliance with qualified plan administration and reporting requirements

46 Executive Compensation: Section 280G A parachute payment is a compensation payment that: Is made to an officer, shareholder or highly compensated employee, In the aggregate with other such payments is in excess of 3 times the employee s average annual compensation for the 5 preceding years ( Base Amount ), and Is contingent upon a Change in Control a change in the ownership of the corporation (50% of vote or value), a change in effective control of the corporation (20% of vote acquired within 12 months or board coup), or a change in the ownership of a substantial portion of the assets of the corporation (at least 1/3 of FMV of assets)

47 Executive Compensation: Section 280G If parachute payment, then: Employee subject to a nondeductible 20% excise tax on amount over Base Amount, which must be considered in wage withholding, and Employer cannot deduct amounts in excess of Base Amount Some employment agreements require the employer to grossup the executive for excise tax, which can substantially increase the cost to the company. Moreover, such payments are considered excess parachute payments and are also nondeductible.

48 Executive Compensation: Section 280G Payments, the vesting of which is accelerated, are included in the computation of a parachute payment to the extent of the present value of the acceleration. This may apply to both: Unvested options Restricted stock Exceptions to parachute payments can present planning opportunities: Reasonable compensation (including reasonable compensation for non-competition agreements) with clear and convincing evidence Payments by private companies if 75% of shareholders approve the payment after adequate disclosure of all material facts

49 Private Company Costs Consider potential for excessive compensation to shareholders Inquire regarding personal expenses deducted as corporate expenses Inquire regarding related party transactions Be sure to read the offering memorandum and management s adjustments to reported EBITDA these often provide a roadmap to potential issues in this area

50 Non-income Taxes Common areas of non-income tax diligence focus Sales/use taxes Non-filing/nexus issues Improper use of exemptions Payroll taxes (covered previously under executive compensation and benefits) Independent contractors Improper reporting of shareholder or executive payments Property taxes Tax abatement arrangements Property misclassifications Potential increases in tax assessments Customs duties Product misclassifications Underreporting of value Not an all-inclusive list!

51 Non-income Taxes How do you address non-income taxes where a large volume of tax returns and tax reporting jurisdictions makes it impractical to analyze them all? Focus on apportionment or similar schedules to determine the volume of activity by jurisdiction Make general inquiries regarding: The procedures employed by the company to determine nexus/filing requirements, classify property or transactions and determine taxability The nature of any exemptions or abatements claimed The outcome of previous tax audits Exposures identified by the company Specific tax planning strategies Based on the results of the above, consider whether it is appropriate to request and analyze returns or documentation on a test basis, focusing on the most material items or jurisdictions

52 State and Local Taxes Key Focus Areas Buyer s Due Diligence General Issues Stock Sales IRC 338 and State Taxes Tax Attributes Post-Acquisition Structuring and Related Issues Sales Tax Issues

53 State and Local Taxes M&A Due Diligence Goals of due diligence process Pre-existing tax liabilities Known Issues Possible problem areas Nexus issues Sales taxes are often ignored Unclaimed property is also often ignored Return filing issues Prior transactions Planning issues

54 State and Local Taxes Nexus Issues Obtain and review state tax returns of the Target for all open tax years Review apportionment summaries prepared by the Target Quantify the potential liability related to non-filing states Tax years are open to assessment if no tax reporting has been made

55 State and Local Taxes State Treatment of a 338(h)(10) Election Most states automatically accept the election if made for federal purposes Some states, e.g., CA and WI, allow for a separate election and permit opting out of the federal treatment Some states did not recognize the election due to concerns that it was tied to the federal consolidated return regulations Federal changes allowing nonconsolidated affiliates and S corporations to make the election may have alleviated many of those concerns

56 State and Local Taxes 338(h)(10) State Return Issues If a state adopts the federal provisions: Generally require short period returns to match federal short period returns If a state does not adopt the federal provisions: Generally require taxpayers to file a one day return, or May follow the federal return periods, but require both Buyer and Seller to report the gain Special apportionment required at times

57 State and Local Taxes 338(h)(10) Liability Issues If state follows the federal election: Generally will follow federal concept that places liability for the deemed sale on the selling consolidated group If state does not follow the federal election: It may not be clear which party is responsible If the default election is under 338(a), generally the liability for the deemed sale belongs to the Purchaser

58 State and Local Taxes 338(h)(10) Due Dates Trap for the Unwary States not adopting the consolidated return regulations: May require returns to be filed within normal period following year end Trap - corresponding federal return may not be prepared until many months later Issues - filing returns, tax payments, estimated tax payments Resolution may require negotiation with the state or request for waiver of applicable penalties, and the filing of a best guess return

59 State and Local Taxes IRC 381 Issues Apportionment of losses Most states calculate the NOL in accordance with federal rules and then apportion it to the state, e.g., CA, AZ, CO Some states limit the amount and period of carryover, Some states restrict carryback and only allow carryforward Combined report - may require a combined loss to be intrastateapportioned to each member of the unitary group A corporation with a separate company profit may be assigned a portion of the combined group s NOL based on its share of the factors in the state Note: Should be subject to special scrutiny during due diligence losses claimed may not be equivalent to losses allowed

60 State and Local Taxes State Adoption of IRC 382 Some states adopt 382 by reference Some states adopt 382 by inference Some states do not adopt 382 at all Note: IL recently changed its position on 382. Taxpayers should be certain to re-evaluate, if necessary.

61 State and Local Taxes Related Issues Tax clearance and assumption of liabilities Qualification or registration to do business Withdrawal of qualification or registration Local business licenses

62 State and Local Taxes Consolidated Returns and E&P 311(b) requires the distributing corporation to recognize gain on the distribution of appreciated property. In connection with distributions of appreciated property from subsidiary to parent, gain is generally deferred under the consolidated return regulations. The DIT is not recognized until the property leaves the group or another triggering event occurs.

63 State and Local Taxes Multistate Implications of IRC 357(c) Transactions Flip-side of 311(b) Gain will be recognized if, as part of a 351 exchange or certain reorganizations, certain liabilities are transferred that exceed the adjusted basis of the property transferred Recognition of the gain is deferred within a federal consolidated return and state unitary combined (or consolidated) returns Recognition of the gain is generally not deferred in separate return states

64 State and Local Taxes Sales & Use Taxes Purchase of a Business Step 1 The application of sales and use tax to the sale/merger transaction Successor s Liability Step 2 Evaluation of the sales and use tax transactions of the Target

65 State and Local Taxes Exempt Sales/Purchases of a Business General Categories: Sales by persons not defined as sellers as defined by the Sales and Use tax law Sales by occasional sellers (casual or isolated) Transfers of substantially all property without change in ownership Statutory Mergers Contributions to Commencing Corporations Successor s Liability Due Diligence Evaluation of the Target s sales and purchases

66 State and Local Taxes Due Diligence Perform a review of a target to determine if significant sales and use tax exposures exist. This is usually performed in a very tight time frame Each Target s business operations, product taxability, materiality, time frame and other unique factors, will stand on its own Evaluation of Target s Sales & Use Tax Exposure Identify Target s nexus: Non-filer states generally have an unlimited look-back period Determine Target s multi-state sales tax liability Review all state sales tax returns and prior audits for prior 3-4 years

67 State and Local Taxes Reviewing State Sales Tax Returns Determine that: Sales taxes are properly collected from customers and remitted to the states Use taxes are properly recorded All exempt sales are properly supported All exempt purchases are properly supported

68 Due Diligence Case Study 1 Target, a publicly traded C corporation, is a supplier of new and remanufactured starters and alternators for import and domestic cars and light/heavy duty trucks. These replacement parts are sold for use on vehicles after initial vehicle purchase. Target s products are sold exclusively into the aftermarket through warehouse distributors, independent retailers, and big box retailers throughout the United States, Canada, South America and Europe. In addition, Target operates its own branded retail stores in various states. Target operates three domestic manufacturing facilities located in Pawtucket, Rhode Island; Granite Falls, North Carolina; and Bakersfield California. Target also operates manufacturing and distribution centers in Rotterdam, Netherlands; São Paulo, Brazil and Mississauga, Ontario. Target additionally opened a new facility in Monterrey, Mexico in Target s subsidiaries in foreign jurisdictions purchase certain materials and receive managerial services from Target. Target and foreign subsidiaries also exchange certain engineering services. Target files a consolidated US corporate income tax return with its US subsidiaries on a calendar year basis. Tax Advisors represented that Target has filed an extension for the tax year consistent with prior tax years. Target expects to report estimated taxable income of $15.0 million in the current year. Target has approximately $6.3 million of NOL carryforwards from a prior tax years.

69 Target is an S corporation headquartered in Byron, NY. Target develops, manufactures and sells harvesting equipment and related parts. Target also leases harvesting equipment under short-term seasonal leasing arrangements and provides equipment repair services. While Target has two Qualified Subchapter S subsidiaries, it does not have any foreign subsidiaries or other business establishment outside of the US. Target s sales are made throughout South America, Europe and Australia. A few individual employees occasionally travel to South America to solicit sales. Sales in Europe and Australia are coordinated through third party distributors. Target was incorporated as a family business on August 14, 2010 and reports as an accrual method taxpayer. On January 1, 2013, Target elected to be taxed as an S corporation with a December 31 TYE. Target files annual US federal income tax returns. Target is currently owned by both individuals and family trusts. However, to incentivize employees, Target also currently has a stock option and restricted stock plans in place. The Target currently leases its property from the patriarch of the founding family who owns the real estate in a separate entity. Another family member/shareholder also has a personal loan in place with Target.