For many years, based on a prior U.S. Supreme Court decision, a business had to have physical presence (generally property or employees, permanent or transitory) in a state for such state to be able to require an out-of-state seller to collect and remit sales tax in that state. In 2018, the U.S. Supreme Court decision in South Dakota v. Wayfair (generally referred to simply as Wayfair) upended that long-standing theory and held that in-state, physical presence is no longer necessary for a state to subject a business to sales tax. Rather, merely having either a certain amount of sales or transactions in a state may create sales tax obligations.
The decision has implications for all companies, new or old, across all industries, which sell any nature of goods or services to U.S. customers across state lines. Moreover, Wayfair may also have implications beyond sales tax, such as for gross receipts taxes, which are imposed by some states and localities.
As sales taxes and gross receipts taxes are applied on gross sales, the cost of errors in compliance can be significant – and Wayfair only adds to that risk by expanding the number of jurisdictions in which a business may be taxable. As such, it’s important that Wayfair be addressed in buy-side DD, as well as for existing portfolio companies, to avoid costly issues during a holding period and on exit.
Here’s a quick summary of what Wayfair could mean for sponsors and their portfolio companies:
What does the Wayfair decision change about how sales taxes are levied?
There are generally two key determinations to be made with regard to sales tax:
Does the business have “nexus” in the state where the goods or services are sold or used (historically nexus was physical presence, now it’s physical and potentially economic presence in a state)? And;
- Are the goods or services subject to sales tax in that state?
Wayfair only changes the nexus standard, so #1 above. The result of that change is likely an expansion of where many businesses have nexus, and thus potentially an expansion of sales obligations in more states.
Who is impacted by the Wayfair decision?
All sellers of goods and/or services to customers in states or localities that impose a sales tax can be impacted by the Wayfair decision, including some non-U.S. businesses selling into the U.S.
- Online retailers: Likely have to collect and remit sales taxes on more, or potentially all, of their sales going forward upon establishing economic nexus, regardless of whether they have any physical presence in a state.
- Online service providers (SaaS and similar businesses): May have significantly more sales tax obligations as they may now have nexus in more states that tax their services. This is a complex area rife with errors, and Wayfair will only exacerbate the issue for many businesses.
- Businesses that rely on resale or other exemptions: May end up with increased compliance burdens due to the need to qualify for the resale of other exceptions in a number of new states, and they may not qualify for sales tax exemptions in all new states.
- Non-U.S. businesses selling into the U.S.: May now need to collect and remit sales taxes on sales into certain U.S. states (or document exempt sales), where previously they avoided such obligations as they had no physical presence in the U.S., or the specific states in question.
What do PE deal-makers need to be thinking about on the buy-side?
Wayfair and economic nexus needs to be assessed in the tax diligence process. A&M is already including this in all our diligence reviews, but getting the right data to accurately estimate the risk in a competitive deal process can be challenging. As such, open and consistent communications between deal team and diligence providers about the diligence process (e.g. how hard to push), and the practical level of risk, are important.
Where exposures are identified, normal contractual protections can be considered, though identified issues will likely be excluded from any R&W policy.
Additionally, one incremental provision that should be considered is VDA rights. VDAs are voluntary disclosure programs, and these programs allow a non-compliant company to fix their historical sales tax issues in a state - and often avoid penalties. Without the right to complete VDAs or similar programs, a buyer may not be contractually allowed to clean-up historical issues, and the exposure could continue to grow post-close unless/until the issue is addressed.
What should sponsors be doing right now with existing portfolio companies?
Every business that sells good or services across state borders should be considering the impact of Wayfair on their sales tax obligations. For some businesses, especially ones that are already collecting and remitting sales tax on most or all their sales, the impact may be insignificant. For others, Wayfair could create new filing obligations and create the need for more or better focus on sales tax compliance.
Though states are still responding to Wayfair and its full implications are yet to be seen, enough is known to react at this time.
As such, we recommend sponsors consider the following:
1. Discuss and understand how their portfolio managers are addressing Wayfair.
- A reasonable starting point is often performing a high-level nexus and taxability analysis in states where the business has material sales. If real areas of risk are identified, a more detailed review can be undertaken.
- This doesn’t have to be a huge and costly undertaking, it can generally be done time and cost efficiently if the right resources are focused on it.
2. Prepare for exit by reviewing sales tax, and specifically Wayfair implications, before bidder DD begins.
- It’s generally better to be prepared for the questions and challenges that bidders will present.
- It may also be possible to address and remediate certain issues prior to a sale, or at least quantify the issue and prepare the remediation plan to control the discussion, and quantification, of the issue in deal negotiations.
3. Consider a portfolio wide Wayfair review if a portfolio, or subset of businesses, has material exposure to Wayfair and sales tax issues, and/or portfolio management is not well equipped to address the issues.
4. If portfolio managers could use some help, feel free to share this email with them and we’re always happy to schedule a quick call to help them think through level of risk and what options they have to address these issues.