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Business Law Today

Avoiding Successor Tax Liability in a Sale of Business Assets
Protecting the Purchaser's Interests
By Raymond P. Carpenter Sr.
A company that purchases the assets of another company does not expect to acquire the existing tax or creditor obligations of its seller. In fact, the asset purchase transaction is designed to avoid the transfer of obligations that is a recognized feature in a purchase of company stock. State governments, however, have developed laws designed to assess derivative liability on purchasers of business assets where the seller is delinquent in certain state taxes at the time of the sale. This article is designed to identify the circumstances under which state law will impose successor tax liability on a purchaser of business assets and provide some instruction on how to successfully avoid the imposition of such liability.

Obligation of a Successor
Any purchaser of all or substantially all of a business or stock of goods of a business is liable for the seller's tax liability. The purchaser is required to withhold and remit to the state a sufficient amount of the purchase money to pay the seller's tax liability upon the purchase. The purchaser is relieved of such liability by receiving from the seller a receipt from the director of the department of revenue showing that the taxes have been paid. If the seller fails to provide the receipt or certificate from the department of revenue, stating that no tax is due, the purchaser will be liable personally for any tax, penalties, and interest due at the time of the sale.

The purpose of the successor liability laws is to secure the collection of taxes by imposing derivative liability on purchasers of a business who are generally in a better financial position to collect or pay taxes from the sales price than the seller who is quitting the business. The clear intention of the state laws in this regard is that the tax debt will follow the business, its assets, or any portion of them.

Because the successor liability statutes have a public purpose, courts in most states have given the statutes a broad interpretation in order to effectuate that purpose. For example, in Tri-Financial Corp. v. Dep't of Revenue, 495 P.2d 690 (1972), the Washington State Court of Appeals found that a lessor of equipment who entered into a cancellation of the equipment leasing arrangement with a defaulting lessee and who began operating a business similar but not the same as his lessee, was nonetheless a successor to the lessee and liable for his unpaid taxes. The former lessor purchased equipment and supplies from his former lessee and gave a note for the purchase price, which was held by an escrow agent in order to satisfy known tax obligations of the former lessee to the Internal Revenue Service (IRS) and to the state of Washington. However, the note was seized by the IRS for its taxes, and the state of Washington brought an action against the former lessor as a successor in interest to its former lessee for state taxes due and unpaid from the lessee.

The lessor argued that it was not the successor to its lessee because it had not purchased the assets of its lessee and the lessee's business operation had ceased to exist when the lessor began to operate its business. The Washington Court of Appeals ruled, however, that the lessor was indeed a successor as that term was used in the statute because it had succeeded to the business of its former lessee and the successor liability statute was a reasonable means of making certain that delinquent taxes of a business are not avoided by the artifice of selling off the assets of the business. According to the court, "The tax debt has been made to follow the business, its assets or any portion of them."

The Washington court was persuaded that the interest of the state in the collection of its tax revenue requires a broad interpretation of the terms within the statute to achieve the state's purpose. It cited with approval this rule of construction as applied in the courts of Missouri, Tennessee, and Wisconsin in similar cases. So, a successor may not only be one who is a direct purchaser of assets of a prior business but one who indirectly takes the assets and operates a successor business operation. Successor liability consequently may be asserted even in circumstances where the successor is not a direct business successor but the assets of the defaulting business can be traced to a successor business.

In a similar case the Missouri Supreme Court approved the extension of liability, recognizing that the successor was not an "immediate successor" but arguing that the Missouri statute imposes liability on "all successors." This court found that the statute contemplates a series of successors, placing on the immediate purchaser the duty to ascertain whether any taxes are due and, if so, to withhold purchase money. "Personal liability attaches to the purchaser of the property as that person can best protect the state's interest and is in possession of the business assets which the tax debt is deemed to follow. The statute specifically provides for the possibility of intervening successors so that a tax delinquent cannot avoid the tax by a series of transactions." Bates v. Director of Revenue, 691 S.W.2d 273 (1985).

This broad interpretation is not followed in all states, however. The Georgia Court of Appeals was not willing to give the state similar latitude against a purchaser who took the assets of a predecessor without notice of the state's interest in the assets. In Graham v. Palmtop Properties, 645 S.E.2d 343 (2007), SSC operated an automobile repair and retail gasoline business. When SSC became delinquent in its tax payments to the state of Georgia and trade creditors, it was purchased first by the shareholder/owner of the corporation and operated in his own name before selling to an unrelated third-party purchaser. The third-party purchaser then incorporated an entity to operate the business and properly began filing its own tax returns. The Georgia Department of Revenue (DOR) proceeded against the new entity as a "successor" to SSC (using an alter ego and in the alternative a "nominee" theory of liability). DOR had not recorded its lien, and the new owner took the property without notice of any claims against its seller or SSC with which it had no connection. According to the court, if the state had recorded its lien against the property, the third-party purchaser would have been on notice of the state's claims. However, since the lien was not recorded, the purchaser had no way to protect himself against liability for remote predecessor taxes, and the court refused to find that the third-party purchaser was a successor in interest, holding that it was therefore not liable for taxes of a remote predecessor.

This case represents a definite minority position on the imposition of successor liability but still stands as one case in which a court was willing to limit the application of a broad statute. Its position was ". . . Revenue laws are neither remedial statutes nor laws founded upon any permanent public policy, and are not, therefore, to be liberally construed; and hence whenever there is just doubt, that doubt should absolve the taxpayer from his burden."

State Provisions
In order to avoid the liability of its predecessor, a purchaser should take care to give the taxing jurisdiction adequate notice that a sale is about to occur, even if he or she does not know whether the seller will continue in business. This will protect the purchaser in the event that the seller later determines to cease business operations with the disposition of these assets. The purchaser should inquire of the seller's home state the exact extent of any outstanding tax obligation owed by the seller.

The notice to the state taxing authority provides the purchaser legal protection that it will not be held liable for taxes due from its seller while the seller was in possession of the business or the business assets. New York, for example, requires that it receive notice of a bulk sale of assets at least 10 days prior to the date of closing. If the notice is received at least 10 days prior to the date of closing, New York must give notice to the purchaser within five days that tax may be due. It will then have an additional 90 days to review the seller's books and records and to assess any tax that may be due. If the state does not make the assessment within 90 days of having received notice of the sale, tax liability may not be assessed against the purchaser. The purchaser may be required to withhold funds sufficient to discharge any tax liability that is determined to be due, and the failure to withhold will make the purchaser personally responsible for any taxes assessed within the 90-day period.

Connecticut requires that it receive notice of a bulk sale of assets 90 days before the closing. The Department of Revenue Services then will have 60 days from the date it receives all required information to either issue a tax clearance letter to the seller or an escrow letter requiring the withholding of funds for potential taxes that will be assessed after audit. If no escrow letter is issued within 60 days of receiving the notice of the sale, the purchaser will not be held liable for any taxes due from the seller.

Wisconsin, on the other hand, requires that it receive the request for clearance after the date of closing. The Department of Revenue must act on the request either by issuing the clearance certificate or issuing a notice of potential successor liability within 90 days of receiving the completed request for the clearance certificate. If the Department of Revenue does not respond within 90 days, the purchaser is relieved of any liability.

Georgia has no statutorily required time period within which the notice of the sale must be received for the issuance of the certificate. The purchaser should take into consideration that the department of revenue will require some time period to review the seller's account before making a determination of liability or potential liability. For this reason, early notice should produce the best results.

Liens for taxes due to the state arise at the time the taxes become due and payable and cover all property in which the taxpayer has an interest from the date the lien arises until such taxes are paid. The priority of liens is generally spelled out in Official Code of Georgia Annotated §_48-2-56(a). The liens for taxes arise at the time the taxes become due and are unpaid, and the lien covers "all property in which taxpayer has any interest from the date the lien arises until such taxes are paid." Tax liens are superior to all other liens and are required to be paid prior to any other debt, lien, or claim of any kind. It should be noted that claims for Internal Revenue Service administered taxes are superior to all state tax liens, regardless of when recorded. The lien for ad valorem (property taxes) on real property will only be superior to an after-recorded lien. Other state tax liens are effective when the taxes are due, and the lien need not be recorded to be effective.

The purchaser ultimately is required to withhold a sufficient portion of the purchase price to discharge any potential tax liability pending clearance from the department of revenue. Failure of the purchaser to withhold sufficient taxes will subject the purchaser to personal liability for any unpaid taxes of its predecessor. Most of the litigated cases on this subject involve purchasers who have for some reason failed to follow this clear path to protect themselves. Perhaps the asset purchase agreement, which contains an indemnity by the seller to hold the purchaser harmless from any taxes owed by the seller at the time of the closing, has caused this omission. The seller also generally represents and warrants that there are no such taxes due that have not been fully discharged. Purchasers should be aware that these provisions may give the purchaser a legal claim against a seller who may be liquidating its holdings and moving to a remote jurisdiction where legal action will be expensive and only partially satisfactory. Better to resolve these matters at the closing by withholding a portion of the purchase price until all assurances from the taxing jurisdiction are received.

Successor liability for state taxes is generally limited to the sales and use tax and any other excise taxes collected and reported to the state by tax dealers, including admissions taxes and event fees and taxes. These taxes are generally "trust fund" taxes collected and administered by retail sales tax dealers as an accommodation to the taxing jurisdiction and do not represent the specific tax liability of the predecessor based on its own operations. State trust fund taxes may also encompass state unemployment taxes and state income taxes withheld from employees. Since these taxes become the property of the state from the moment they are identified, the state has a more powerful interest in collecting that which is already state property.

Nonetheless, a purchaser of assets in a restaurant in Michigan was held liable for the Michigan single business tax (the former tax on business activity in Michigan), which was not delinquent or overdue at the time of the sale and did not become due until the end of the year when the return was filed. S.T.C. Inc. v. Michigan Dep't of Treasury (Michigan Tax Tribunal, Docket No. 264636, May 2001). At that time, the predecessor company was insolvent and the state charged the purchaser with the liability. The state justified this unusual result by arguing that the purchaser had failed to obtain a tax clearance certificate or to withhold funds for any potential liability, which would have absolved him of future liability. This result was duplicated in a claim by the city of Mesa, Arizona, against the purchaser of a motel when it was discovered after the sale that the hotel-motel tax had not been paid. Once again, the purchaser had not obtained a clearance certificate nor had he withheld any funds from the purchase price. These results suggest that in spite of the fact that statutes often only refer to the sales and use tax, a broad interpretation of the statutes will often allow the state to seek "any" unpaid taxes attributable to the predecessor which are or become unpaid.

Bulk Sales/Tax Clearance Procedure
Purchasers are often confused that the notice required under the bulk sales or bulk transfer laws is sufficient to put all necessary parties on notice as to the pending transaction. In a number of instances, this discovery has been painful and expensive. The tax clearance procedure under the tax law is similar to but distinct from the notices to creditors under the bulk sales law of the Uniform Commercial Code (UCC) Article 6. The UCC notice is designed to allow creditors of a business that is being sold an opportunity to satisfy their claims before the business can transfer its assets and vanish with the sales proceeds. The bulk sales law applies when a business sells more than half of its inventory and equipment in a sale that is not in the ordinary course of business. The law protects creditors by requiring that a specified advance notice of the sale be published and recorded and that creditors are paid to the extent possible. Notice under the bulk sales law and compliance with its procedures, however, will not protect a purchaser from tax liability for a seller who has delinquent obligations.

In Missouri, purchasers are clearly put on notice regarding the relationship between bulk transfers and tax clearance. See MO. REV. STAT. §§_144.270, 144.705 (2000). Reliance on an affidavit pursuant to Missouri's Bulk Transfer Act stating that there are no creditors of the business will not relieve a purchaser from a previous owner's tax liability.

In a California sale of assets in a grocery store, the seller agreed to obtain a tax clearance certificate from the State Board of Equalization (SBE) to avoid any sales tax obligation on the sale of the assets. On the date of closing, it became clear that the seller not only owed delinquent sales and use tax but had numerous trade creditors as well. In fact, the claims of creditors and the tax authorities exceeded the amount of the purchase price. The purchase money was placed in escrow, and the escrow agent, in order to sort out the competing claims, filed an interpleader action in the circuit court.

An interpleader is an action under the bulk sales laws that allow the purchaser to place the purchase money in the court where that statute sets out a priority to resolve the competing claims. When notified of the interpleader action, however, the SBE informed the purchaser that the issue of successor liability for taxes was not involved in the interpleader action, that in spite of the fact that it had been named, it was not a party to this action, and proceeded to assess the delinquent taxes against the purchaser personally.

The purchaser argued that it had in fact withheld the funds as required by the successor liability statutes and the interpleader action resolved the issue of its liability for any delinquent taxes due from the seller. The California Court of Appeals determined, however, that the withheld funds had never been made available to the SBE to satisfy its claims since the funds were interpleaded in an action that contained the claims of a superior creditor (i.e., the Internal Revenue Service). The interest of the state in collecting its tax revenues exceeds the interest of private parties in their interpleaded claims. The bulk sales law provides a general remedy for creditors, but the successor liability statute gives the state a specific remedy to collect its tax funds. The court noted that the case law in other jurisdictions is consistent on this point, and in this case of first impression in California, a purchaser who failed to comply with the successor liability statues could not discharge his own liability for unpaid taxes in an interpleader action under the bulk sales law. Schnyder v. SBE(3d App. Dist.) Docket No. Co. 38101, 124 Cal. Rptr. 2d 571 (Aug. 23, 2002).

In a similar case in Connecticut, Red, White and Blue Transmissions, Inc. v. Dep't of Revenue Services, 696 A.2d 437 (1994), the court said that the purpose of the successor liability statutes is to secure collection of taxes by imposing derivative liability on purchasers of a business who are generally in a better financial position to collect or pay the tax from the sale price than the seller quitting the business. The Connecticut court also noted that this has been the consistent interpretation of the courts in other jurisdictions when faced with the interplay between the bulk sales laws and the successor liability statutes.

Purchasers should understand that they are required to comply with the bulk transfer statutes and to give notice of the sale of assets to creditors under the UCC. However, the state tax obligation is not an obligation covered under the bulk transfer statutes, and the requirement to notify the state taxing jurisdiction and to obtain its clearance for state taxes is an indispensable part of the sale closing process.

Banks and Financial Institutions
Where the purchaser is a secured creditor repossessing its collateral, will the secured creditor be held a "successor" as that term is used in state statutes and therefore liable for any unpaid taxes to the state? A financial institution or mortgagee that forecloses on a loan to a retailer owing delinquent sales or use tax does not incur successor liability because the bank is not a "successor" as that term is used. In addition, the foreclosure is not a "sale" as that term is also defined in state statutes. If, however, the financial institution actually operates the business which has been voluntarily surrendered to it by the delinquent creditor in full or partial liquidation of a debt, the creditor becomes a successor. The creditor is not a successor if it acquires possession of a business but never operates the business. (See The Citizens Nat'l Bank of Stevens Point v. Wisconsin Dep't of Revenue, S-9711, Wisconsin Tax Appeals Commission, and Tri-Financial op. cit.)

A Florida court reached a similar result for a different reason. When a security interest was perfected prior to the recording of the tax warrant by the Florida Department of Revenue and the outstanding amount of secured debt was in excess of the value of the property, there was no "purchase money" as required by the statute from which to withhold a sufficient amount to cover the tax liability, nor was there any equity in the seller to which a tax warrant could be attached. See Screens Unlimited, Inc. v. Aetna Ins. Co., 37 Fla. Supp. 175 (Fla. Cir. Ct. Pinellas County 1972).

In addition, a repossession of collateral or a judicial foreclosure is not the type of "sale" to which the statute refers when it refers to the "sale of the business or stock of assets." The sale contemplates a willing purchaser and willing seller bargaining in the market price over the value of goods subsequently exchanged. In a repossession, the creditor already has title to the goods and is simply repossessing or taking back what is already his. Therefore, the actions of the bank or other secured creditor, are for an additional reason, not the type of transaction to which the successor liability statutes apply.

Summary of Lessons Learned
In almost every instance, the purchaser failed to follow the clear instructions of the state statute by obtaining the tax clearance certificate or withholding funds sufficient to discharge any tax liability due at the time of the closing. Compliance within the context of an approaching closing may often be difficult, if not impossible, given the shifting time frames involved in a closing and the unforeseen events that delay and alter the transaction. With these contingencies in mind, counsel for the purchaser should never close without a tax clearance certificate in hand or an estimated amount of funds sufficient to discharge at least the potential sales tax liability in the bank. Following this rule will allow the purchaser some certainty as to the actual cost of the acquisition. Failure to follow the terms of the statute may result in costly litigation and business disruption from unanticipated state tax claims.

Carpenter is a partner at Holland & Knight LLP in Atlanta. His e-mail is raymond.carpenter@hklaw.com.

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