August 15, 2016
As published in the Connecticut Law Tribune – August 15, 2016
Herman Melville once wrote: "[a]ll my means are sane, my motive and my object mad." The object of my obsession, and that of many practitioners who deal with the purchase and sale of small businesses in Connecticut, is having a smooth, seamless, efficient and timely closing of the sale. What can often seem to be the "great white whale" in this process: appropriately addressing successor liability with the Department of Revenue Services.
The buyer of a business in Connecticut must be vigilant of potential successor liability, or tax consequences that the buyer could inherit from the seller of the business under C.G.S., Section 12-424. To address this potential liability, the buyer or buyer’s representative must apply to the Department of Revenue Services ("DRS") for a tax clearance certificate. But the DRS cannot issue such a certificate until after the final tax return is filed which by definition occurs after the closing.
Historically, DRS has been helpful in issuing escrow letters to allow a closing to proceed even without a tax clearance letter Essentially, these letters serve to cap or limit the potential successor liability of the buyer. The issuance of this letter allows the sale to progress, with the buyer simply holding back from the purchase price that sum which relates the capped value of successor liability the buyer could face.
However, with the increasing pressure on the State budget, the DRS has recently followed a more cumbersome alternative to the issuance of the tax clearance certificate by choosing to institute a compliance audit in response to a request for a tax clearance certificate or escrow letter. A major concern with triggering a DRS audit is that there is no apparent way to avoid or anticipate it. There are no statutes, regulations or other policies in place that define or constrain the ability of DRS to conduct an audit.
What can truly make a DRS audit troubling for both parties to the transaction is the delay that it represents to the efficient and timely closing on the sale. Per statute, DRS has sixty days to complete their audit and issue the certificate or notice of unsatisfied tax liability. Despite this 60 day time limit, this author has seen multiple instances where the audit is not completed in 60 days. In the world of small business transactions, sixty days can be a millennium, an eon, an eternity. In fact, many of these transactions have collateral contingencies, such as those related to financing or property acquisition, for which a sixty day delay can essentially sound the death knell for the entire transaction.
In recent months my office has had the opportunity to correspond on this very issue with Commissioner Kevin B. Sullivan of DRS. Of course, the Commissioner and the State have the dual concern of not unduly burdening business transactions, while also ensuring that business transactions such as these are not an opportunity to evade taxes through restructuring. That being said, it is incumbent upon, and perhaps even professionally required, that an attorney representing a seller of a small Connecticut business inquire from DRS whether a compliance audit is likely to be conducted so that this contingency can be appropriately reflected in the contract and the timing worked out accordingly. To save as much time as possible, it would be prudent for the seller to make such inquiry before seller places the business on the market. The Department of Revenue Services has indicated a willingness to advise a perspective seller whether an audit will be required assuring some degree of comfort to the contemplated closing details.