Business buyers often fail to put enough time and effort into doing proper due diligence. But now, in Georgia, that could cost them.
A new ruling by the Georgia Supreme Court can leave a purchaser responsible for the seller’s delinquent sales taxes. Michael S. Evans, attorney at law with Baker, Donelson, Bearman, Caldwell and Berkowitz PC in Atlanta, says there are things a business can do to avoid this.
Smart Business spoke with Evans about the new law and how a purchaser can avoid “getting stuck holding the bag.”
The Georgia Supreme Court recently made an important ruling regarding the purchase of a business. What was it?
The Georgia Supreme Court ruled on June 4, 2007, in the tax case of JD Design Group Inc. versus Graham, that the purchaser of substantially all of the assets of a business was liable as a successor in interest for delinquent Georgia sales taxes owed by the seller. In that case, the purchaser agreed to buy substantially all of the assets of the seller’s business, including real estate used in the business. The purchaser later assigned the right to buy the real estate to its sole shareholder. Although the seller represented in the purchase agreement that all of its taxes had been paid, and the purchaser’s title search on the real estate didn’t show any liens, the purchaser didn’t require that the seller obtain a tax clearance letter from the Georgia Department of Revenue certifying that the seller had no unpaid taxes.
The purchaser would come to regret that decision several months later when the Department of Revenue sent the buyer an official assessment and demanded payment for almost $25,000 of the seller’s outstanding taxes. They later sent an additional assessment for almost $7,000 more.
Georgia law has long provided that the purchaser of a business must withhold a sufficient amount of the purchase money to cover the business’s unpaid sales taxes until the seller provides either a receipt from the Department of Revenue showing that all taxes (including interest and penalties) have been paid or a certificate from the Department of Revenue showing that no sales tax is due. A purchaser who fails to withhold purchase money until receiving either a receipt or a tax-clearance certificate is liable for the seller’s unpaid sales tax, including interest and penalties, to the extent of the purchase price. Failure to comply with this successor liability statute can also result in a misdemeanor charge.
The purchaser challenged the tax assessment on the grounds that it wasn’t a successor to the seller because it didn’t buy all of its assets (since the purchaser’s shareholder bought the real estate) and was just an innocent purchaser for value, and the Department of Revenue’s failure to record a lien should bar it from imposing liability beyond the original party. The Georgia Supreme Court wasn’t persuaded by any of those arguments, though, holding that the successor liability statute applies to sales of less than all of a business’s assets and that the purchaser could have protected itself by complying with its affirmative duty to get a tax-clearance certificate.
What do buyers of a business need to do to avoid ‘getting stuck holding the bag’?
The JD Design case should remind buyers to require in their purchase agreements that the seller provide a tax-clearance letter as a condition of closing. Buyers should also include tax indemnities in the purchase agreement requiring the seller to indemnify the buyer against any successor tax liability, though that may not help if the seller spends all of the purchase money.
How is the Department of Revenue involved in such a transaction?
Although the Department of Revenue can pursue the buyer directly without trying to collect delinquent taxes from the seller, it will typically get involved when it tries to collect from the seller and learns that the seller has sold its business and doesn’t have enough money to pay the taxes.
Does a company have any legal options to pursue if it doesn’t get a tax-clearance letter?
The buyer is required to withhold a portion of the purchase price sufficient to cover the seller’s outstanding taxes, interest and penalties. If the buyer doesn’t withhold and doesn’t have a tax-clearance letter, then its options are pretty limited.
What other things should individuals be aware of when purchasing a business?
Business buyers often fail to put enough time and effort into doing proper due diligence. They should remember that a thorough investigation prior to buying the business can save them a lot of headaches down the road, and that the seller’s creditors may not be prevented from recovering from the buyer just because the buyer pays fair market value for the seller’s assets. One common method of providing some protection for the buyer is to set aside a portion of the purchase price in an escrow account at closing. The funds can be held in escrow for six to 12 months or more and provide a means to cover indemnification obligations of the seller during the escrow period, so the buyer doesn’t have to worry that the seller will take off with the purchase money and leave the buyer holding the bag. If no claims are made during the escrow period, then the seller will normally get the escrowed funds.
MICHAEL S. EVANS is an attorney at law with Baker, Donelson, Bearman, Caldwell and Berkowitz PC in Atlanta. Reach him at (404) 221-6517 or firstname.lastname@example.org.