Why it matters
Unpaid tax does not disappear when a business changes hands. Sales tax, VAT or GST, payroll taxes, income or corporation tax, property taxes and customs duties can all be owed for periods before you took over, along with interest and penalties.
In a share sale (a stock sale in the US), the company you buy keeps its full tax history. Any underpayment, late filing or open enquiry stays with it and becomes your problem. Buyers usually protect themselves with a tax indemnity (often called a tax covenant in the UK) and warranties from the seller, and by holding part of the price in escrow or as a holdback. An indemnity is only as good as the seller's ability to pay when a claim arrives, which may be years later.
An asset sale lowers the risk but does not remove it. In many US states, a buyer of business assets can become liable for the seller's unpaid sales and use taxes unless the buyer follows the state's process, which can mean notifying the tax authority before paying, holding back part of the price or obtaining a tax clearance certificate. In the UK, a buyer who takes over the seller's VAT registration number when a business transfers as a going concern also takes on the seller's outstanding VAT. Rules differ by country and by type of tax, so take advice from a tax adviser in each country where the business operates.
Tax problems also say something about the records. A business that has not paid what it owes may also be understating income, treating employees as contractors or keeping cash sales out of the accounts. Loupe's valuation tool reduces the multiple, at its starting settings, by 10% where some legal, tax or compliance issues are known, and by 30% with confidence set to low where they are significant.
In an asset sale you buy selected assets of a business; in a share sale (a stock sale in the US) you buy the company itself, with its full history. The choice shapes risk, tax and what needs consent.
Warranties are the seller's statements of fact about a business in the purchase agreement; indemnities are promises to reimburse specific losses. Together they decide who bears risks that diligence could not rule out.
Escrow is an arrangement in which an independent third party holds money until agreed conditions are met. In a business sale it keeps part of the price available to cover claims after completion.
How to spot it
- Tax balances on the balance sheet keep growing, or the business is on a payment plan with a tax authority.
- The ledgers show late filing penalties, interest charges or notices from tax authorities.
- The business sells online into several states or countries but collects tax in only one.
- Workers are paid as contractors, or staff receive cash payments.
- The accounts and the tax returns show different figures.
- The seller pushes for an asset sale with no clearance process, or resists a tax indemnity.
Questions to ask the seller
- Are all tax returns filed and all taxes paid to date, for every tax and every country?
- Is the business under audit or enquiry, or in a payment arrangement with any tax authority?
- Where does the business collect sales tax, VAT or GST, and how was that decided?
- Have any penalties or interest charges been applied in the last three years?
- Can you obtain tax clearance or good standing certificates before completion?
- Would you agree to a tax indemnity, and to part of the price being held back until clearance arrives?
Documents to request
- Tax returns for the last three to five years, for every tax the business files
- Statements from tax authorities showing balances, payments, penalties and interest
- Correspondence with tax authorities, including audit and enquiry letters and payment plans
- A list of the places where the business is registered for sales tax, VAT or GST
- Payroll tax filings reconciled to the payroll records
- Tax clearance or good standing certificates, where the country or state offers them