STOCK OR ASSET SALE
Sales of stock of a corporate business or membership interest in a limited liability company (“LLC”) typically favor the Seller and provide a lower overall tax burden or liability. However, stock sale generally does not provide the Buyer with any increased basis for income tax deductions such as depreciation. A stock purchase also makes the Buyer vulnerable or at risk to any possible liabilities of claims against the prior business operations. Careful analysis and consideration must be given to both the actual tax effect and the potential for future liability.
Many Buyers will require that a sale be structured as an Asset Purchase in order to avoid responsibility for prior liabilities or expenses of the business. However, a Buyer may still have liability for such expenses in the event that the Buyer acquired more than one-half (1/2) of the Seller's inventory and equipment as measured by the value of those items on the date of the Bulk Sale Agreement (See Commercial Code Section 6102(a)(3)). In order to insulate the Buyer from such prior expenses or liabilities, the Buyer must comply with the bulk sale notice requirements set forth in the California Commercial Code. The Bulk Sale Notice generally includes the name and business address of both, the Buyer and the Seller as well as any other business names and addresses used by the Seller within the last three (3) years. The Notice includes the location and the general description of the assets to be sold as well as the place and anticipated date of that sale. The Notice must be recorded in the County Recorder office in each county or counties in which tangible assets are located. The Notice must also be delivered by certified or registered mail to the County Tax Collector in the county or counties in which tangible assets are located. There are certain exceptions to the Bulk Transfer provisions for certain types of business or business purchased out of a judicially approved receivership sale. The Buyer should check with his or her representative to ascertain the applicability of the Bulk Transfer Notice requirements.
The Bulk Transfer Act also provides mechanisms for claims to be filed for amounts owed by the Seller. The code provides for payment of agreed claims out of the sale proceeds and a mechanism for the Seller to dispute whether such a claim is actually payable. Notice should also be provided to the California Board of Equalization and to the Employment Development Department in order for the Buyer to obtain separate releases for both sales and payroll taxes.
Since the primary purpose for complying with the Bulk Sale Transfer provisions is to protect the Buyer from unforeseen liabilities of the Seller, the cost attributable to publication and compliance with the other requirements of the Bulk Transfer Act are typically paid by the Buyer.
Most business sales involve Seller financing. A number of protective devices are available to protect the Seller in the event of the Buyer's default in the timely payment of the balance due. The types of devices used and the restrictions imposed upon the Buyer should be tempered by factors including, but not limited to, the perceived credit worthiness of the Buyer, the amount of the indebtedness owed to Seller as compared to the total purchase price and to the fair market value of the "hard" assets of the business and whether the Buyer is personally liable for the indebtedness owed. The following is a list of some of the common devises used to secure Seller financing:
1. Perfected Security Interest in the Assets Sold. The term "perfected" generally refers to completing those steps legally required to give a secured party an interest in the subject property against the debtor's creditors. Generally speaking, a Security Agreement should be prepared and signed as well as appropriate notices to California Secretary of State for personal property interests. A Deed of Trust should be recorded to secure interests in real property. Fixture filings may be needed to perfect a security interest in fixtures or leasehold improvements. A separate Security Assignment of the leasehold interest should be prepared in order to preserve the Seller's ability to take possession of any leasehold interests for the business premises.
2. Personal Guarantee (Corporate Buyer). In the event that the purchaser of a business is a corporation or other entity with limited liability, the Seller may seek a personal guarantee of the indebtedness owed. Such a guarantee is needed when the perceived value of the hard assets of the business is insufficient to insure repayment of the indebtedness owed. Personal guarantees may be limited both as to time and dollar amount.
3. Restrictions on Distributions from Corporate Buyers. The Seller may seek to restrict the Buyer's ability to make distributions in the form of dividends and/or salaries to corporate officers. This is often perceived by Buyers to be an oppressive security device and is generally resisted by most corporate Buyers.
4. Security Interests in Other Assets. In the event that the perceived value of the hard assets of the business is inadequate to secure repayment of the indebtedness, a Seller may seek security interest in other real or personal property owned by the Buyer.
1. Buyer's Rights of Offset. Buyers will often seek the right to offset payments otherwise due on Seller financing for third party claims or expenses which were undisclosed by the Seller or for breaches in a Seller's Covenant Not to Compete. Again, such rights of offset may be limited both as to time and as to dollar amount. Buyers often desire such rights of offset in order to minimize attorneys' fees in the event that the Buyer is forced to pay prior debts of the business which were undisclosed or in the event that the Seller breaches the terms and conditions of the Covenant Not to Compete. Rights of offset may also be used for breaches of warranty where the Buyer incurs repair costs or other expenses for equipment which was warranted by the Seller to be good and working condition.
2. Due Diligence. The Buyer should be certain to conduct a thorough review and analysis of the Seller’s business operation, financial statements and customer retention. The Buyer should confirm directly with the landlord the status of the lease of the business premises and whether any disputes or issues arose during the Seller’s use of the business premises.
PITFALLS TO AVOID
1. Inadequate Down payment for Installment Sales. The transfer of business assets may trigger depreciation recapture as well as sales or other transfer tax liability. Gain from depreciation recapture generally may not be reported on the installment basis. Therefore, the Seller should carefully review with his or her accountant whether the down payment will be large enough to satisfy the Seller's income tax liability including the potential gain from depreciation recapture. Seller should also review the proposed closing costs and Seller's share, if any, of the sales or transfer tax liability arising from the transfer.
2. Failure to Provide for Payment of Sales Tax. The transfer of the assets of a business may be a taxable transfer for sales tax purposes. Note that the "occasional sale exemption" is generally not available if the Seller has a sales tax permit and is making taxable sales (see Revenue and Taxation Code ("RTC") Sections 6367 and 6006.5). Note also that a one-time sale of assets may qualify as a retail sale subject to the imposition of sales tax even if the Seller has never sold personal property at retail before the asset sale. (seeSanta Fe Energy Co v.Cal. State Board of Equalization (1984) 160 Cal App 3d 176, 182). The Buyer and Seller should each be aware of the sales tax liability, if any, and negotiate for the appropriate payment of that tax.
3. Failure to Limit Successor Liability. Two sets of "Successor Liability Statutes" protect the state of California against business owners who sell their business without paying the taxes due. Each set requires any person who purchases a business to withhold enough cash to cover all amounts Seller otherwise owes for specific state taxes.
3.1. Sales and Use Taxes. When a person liable for sales and use taxes sells his or her business or stock of goods, the Buyer must withhold a specific portion of the purchase price to pay any sales or use taxes owed by the Seller to the California State Board of Equalization ("SBE") (RTC Section 6811). The Buyer is released from the withholding obligation when a Seller produces a receipt from the SBE indicating that any outstanding taxes have been paid or the SBE issues a Certificate of Tax Clearance indicating that no amount is due (RTC Section 6811). Even if all amounts have not been paid, the SBE may issue a Tax Clearance Certificate if the amount due is secured to the satisfaction of the SBE (RTC Section 6813).
3.2. Employment Taxes. The Buyer of a business that employees individuals in the business must withhold in trust either money or other property sufficient to pay any contributions, interest and penalties due or unpaid by the Seller for unemployment compensation insurance benefits or disability insurance contributions (Unemployment Insurance Code ("UIC") Section 1731). The withholding must continue until the Seller produces a certificate from the Employment Development department ("EDD") stating that no contributions interest or penalties are due. If the Buyer fails to withhold sufficient funds, then he or she may become personally liable for the contributions, interest or penalties owed up to the amount of the purchase price (UIC Section 1733). The EDD will generally issue a Certificate of Tax Clearance within thirty (30) days from the written request. The issuance of such a certificate will release the Buyer from any further liability on account of any such contributions, interest or penalties (UIC Section 1732 (b)).