Washington Rules that Sales Taxes Can Apply to the Sale of a Business

Sales tax can be assessed on the sale or acquisition of a business, and parties to a transaction should carefully examine states’ casual sale provisions and exemptions.

When we think of sales taxes, we generally think about everyday transactions in which businesses sell goods (i.e., inventory) to consumers in the normal course of operations. However, sales tax can be a significant and material component of the tax consequences in the sale or acquisition of a business, even though many of those assets being sold are not of the kind normally sold by that business. Generally, a sale of tangible business assets (i.e., non-inventory capital assets) meets the definition of a retail sale subject to sales tax because there is a transfer of title for consideration to an end-user. [1] Therefore, in order for that transaction to be exempt, there must be a specific exemption in the rules.

Most states have written “casual” or “occasional” or “isolated” sale laws which exempt from tax the sale of non-inventory assets used in the operation of a business when the sale results from irregular business activity, such as the complete liquidation of a business or business division. However, each state’s casual sale provision is unique, and attention should be paid to the rules of the state where assets are located.

Washington, for instance, published a Department of Revenue (DOR) determination on July 29, 2016, that illustrates the narrow scope of its “casual sale” exemption. [2] In this determination, Washington ruled against a taxpayer who purchased the entire business assets of a contracting company. The taxpayer unsuccessfully argued that it didn’t purchase the business assets outright for cash, but rather received those assets from its members in an exempt exchange for an interest in the taxpayer.

Washington’s general casual and isolated sales exemption applies only to businesses that are not engaged in an activity that is taxable under its Business and Occupation Tax or its Public Utility Tax. [3] Therefore, the exemption basically applies only to businesses not required to be registered with the DOR. In addition, even if the transaction did qualify for the exemption, it would apply only to sales tax; the purchaser would still be required to pay use tax. [4] Thus, the exemption has very limited benefit.

However, under a Washington regulation, the casual and isolated sale exemption does apply to certain business reorganization transactions. [5] In order for such a transaction to be exempt from sales and use taxes, the transfer must be accomplished through an adjustment in the ownership interest of the business, and the transferor must have previously paid sales or use tax on the property transferred (assuming that the continued use of the property is in Washington). [6]

In this particular case, one of the selling entity’s owners was also an owner of the newly-formed purchasing entity. The seller transferred the business assets, which were under IRS lien, in exchange for cash to the purchaser who began to use them in the operation of the business. Months later, the selling entity’s owner (and also member of the purchasing entity) used a combination of his own funds and the seller’s remaining funds to satisfy the outstanding IRS judgment on the property. The purchasing entity argued that it did not actually obtain the business assets outright from the selling business for cash. Rather, it argued that the seller’s owner first obtained the assets in an exempt distribution and then transferred the assets to the purchaser for his membership interest in the entity.

Washington did not agree with this interpretation, and the taxpayer had no written agreement in place to support it. Since the purchasing entity actually obtained and used the business assets after the seller’s owner was reported as a member of the purchaser and well before the IRS liens were satisfied, the state asserted that there was no continuous ownership by the seller’s member that would indicate an exempt transfer of assets for his ownership interest in the purchaser.

Had the seller and purchaser understood Washington’s casual sale exemption prior to the events and then structured and documented the sale so that the facts actually followed their narrative, sales tax may have been avoided on this transfer. This scenario demonstrates the need for the parties to the sale or acquisition of a business to fully perform their diligence prior to the transaction and take into account all potential state tax consequences. Aprio’s SALT team has experience in navigating the multi-state & local tax consequences related to business transactions. We can advise on your prospective transactions and recommend structures that may result in state and local tax savings.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the September 2016 SALT Newsletter. To view the newsletter, click here.

[1] Any transfer of inventory to the purchaser of the business would still be exempt as a sale for resale.

[2] WA Tax Decision No. 15-0183 (7/29/16).

[3] Wash. Rev. Code § 82.08.0251.

[4] Wash. Rev. Code § 82.12.020(1)(a).

[5] WA Admin. Code 458-20-106. For example, the exemption applies to a transfer of assets to a partnership in exchange for an interest in the partnership or a transfer of assets from a partnership to its member(s) in exchange for a proportional reduction in such member(s)’s interest in the partnership.

[6] The regulation does apply the exemption to transfers of assets between corporations and their wholly-owned subsidiaries, and between wholly-owned subsidiaries of the same corporation. No adjustment to ownership interest is needed since it is 100 percent before and after the transfer(s).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.