Sales Tax 101 (Sales Tax Basics)

Sales Tax Audits & Business Acquisitions

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Sales Tax Audits:

Once a company has been filing sales tax returns in a state, they often become subject to an audit. (Many states have a 3 or 4 year cycle.) The audit may be requested for a variety of reasons – type of industry, size of company, audit of a supplier of the taxpayer, random audit by state taxing authority.

Depending on a company's resources, it is often beneficial to hire someone to assist with the audit. Why? Particularly for a small business owner, it keeps it from becoming personal. Also, if a company is not prepared for interactions with an auditor, they may share too much or too little with the auditor. It is important to keep in mind the objectives of both parties:

1) The auditor objective is to determine the correct measure of tax with the least possible expenditure of time.
2) The taxpayer objective is to complete the audit in the least amount of time and with the least possible liability.

One way to prepare for a good outcome is to come to the audit prepared and with documentation in good order. Things the auditor will request for examination can include: sales tax returns, general ledger, journal voucher documentation, sales journals, inventory work papers, fixed asset documentation, bills of lading and original documents to support all exempt sales (i.e., resale certificates). Note that while it is recommended to be forthcoming with requested information, a taxpayer may also query the auditor as to the reasoning of a particular request if it seems unreasonable, or if it may be difficult to provide. Oftentimes a substitute document might suffice as well.

The auditor will likely:

• Examine general ledger accounts for unreported purchases subject to tax,
• Search for credits to purchases or inventory accounts that represent unreported taxable transactions.
• Review journal entries for indications of transfers of materials from inventory,
• Review a sample of sales invoices to determine if sales tax was properly invoiced,
• Examine purchases to verify that sales tax was paid on the purchase of fixed assets

In dealing with an audit, it is important to be courteous and professional with the auditor at all times, considering also the physical environment in which you ask him/her to work. A taxpayer may wish to have the audit conducted at the location of a third party (CPA, other consultant) to avoid disruption to his normal business activities. This might be a particularly good idea if the taxpayer does not have a conference room or other location where the auditor can work independently.

Sales and Use Tax Considerations for Business Acquisitions:

Before acquiring a target company, the acquirer will engage in a due diligence process, which will include an analysis of the target's state tax exposures. Often during the due diligence process, it is determined that the target has been engaged in business in a given state, sufficient to cause nexus, and has not been collecting and remitting sales tax. If the target's customers have not self remitted the use tax, the company could find itself with some exposure issues.

Why It's Important: Depending on the size of the potential exposure, an acquiring company may choose to forego a deal or reduce the asking price for the target. Any company (publicly traded or privately held) desiring to be acquired should perform its own due diligence (generally by hiring a specialist in the sales/use tax area) to determine any potential exposure areas. All things being equal, a clean bill of health in this area may positively affect the purchase price, while large potential exposures might result in a reduction of the offer.

Don't forget to check the following Sales Tax 101 sections to learn more about sales tax:

Sales Tax 101 - What is Sales Tax?

Commerce Clause to Quill Corp

Sales Tax Nexus, TPP & Exemptions

Sales Tax Registration to Compliance

Internet Tax & SST