When purchasing a business in California, it’s essential to understand the often-overlooked concept of successor liability, as governed by the California Department of Tax and Fee Administration’s (CDTFA) Regulation 1702. Many buyers may assume that, once the sale is finalized, they are only responsible for their new venture’s future operations. However, under California’s Sales and Use Tax Law, buyers can inadvertently inherit the seller’s outstanding tax liabilities if certain precautions are not taken.

This post outlines the key aspects of CDTFA Successor Liability and provides guidance on how to protect yourself during the acquisition process.

What is Successor Liability under the CDFTA?

Successor liability arises when a purchaser acquires a business, or a significant portion of its’ assets, and becomes responsible for the seller’s unpaid ‘Sales and Use’ taxes. These liabilities may include unpaid taxes, interest, penalties, and surcharges. It’s important to note that a buyer’s liability is not limited to amounts known to be outstanding at the time of sale but can extend to liabilities that are
only discovered or finalized after the closing of sale.

Successor liability applies to most contractual business acquisitions where the buyer pays in money, property or assumption of the seller’s liabilities. The law is clear in application: even if a buyer is unaware of any outstanding tax obligations, they may still be held responsible for the seller’s unpaid debts if they fail to take necessary steps. This even includes situations where penalties arose solely from the seller’s negligence, intentional disregard of tax law, or fraudulent actions. However, if successfully challenged buyers may be relieved from penalties associated with the seller’s wrongdoing if there is no significant relationship (such as common ownership) between them.

Why Should You Care About Successor Liability?

In any business transaction, unforeseen liabilities can drastically impact profitability and future operations. Unsuspecting buyers could be required to pay debts accrued from the seller’s failure to pay sales and uses taxes out of the purchase price or from their own funds. This liability risk is not limited to the acquired business itself; it may include taxes on the seller’s sales made before the acquisition, and in
some cases, it may also extend to personal liability for corporate officers under certain conditions.

Failing to account for potential successor liability issues in negotiations can lead to significant financial burdens, legal disputes, and potential enforcement actions by the CDTFA. In some cases, the CDTFA can issue a “notice of determination” against the buyer, outlining the amount owed and triggering their obligations to make payments if not successfully challenged. The state can serve this notice within
three years of the state receiving notice of the sale. The buyer then has thirty days to challenge the notice or the liability becomes final.

How Can You Minimize Your Exposure to Liability?

The good news is that the CDTFA has provided measures for buyers to take proactive steps in mitigating the risks associated with successor liability:

1. Consult Legal and Tax Professional

Given the complexity of California’s Sales and Use Tax Law, it is critical to consult with legal and tax professionals before finalizing any business acquisition. A knowledgeable attorney or tax advisor can help navigate the successor liability rules, ensure compliance, and safeguard
your interests throughout the transaction.

2. Request a Tax Clearance Certificate

One of the most effective ways to protect yourself is by obtaining a tax clearance certificate directly from the CDTFA. This certificate verifies that the seller has no outstanding tax liabilities, or if liabilities exist, it specifies the amount that should be withheld from the purchase price to cover those obligations. Buyers can file a request for a certificate either online by accessing the CDTFA’s online services portal or by written submission at a local CDTFA office.

Without this certificate, the CDTFA may hold you liable for the seller’s unpaid taxes up to the amount of the purchase price. However, if the CDTFA does not respond with a certificate or a notice of tax liabilities within 60 days after the buyer’s request or other triggering events, the
buyer is released from withholding the purchase price. Find more information on Tax Clearance Certificates here.

3. Withhold a Portion of the Purchase Price

If a tax clearance certificate is not obtained, buyers are obligated to negotiate with sellers to be able to withhold a portion of the purchase price to cover any potential tax liabilities. This amount should be remitted directly to the CDTFA to satisfy anything outstanding before the state will issue a certificate of tax and fee clearance for the entity.

4. Escrow and Due Diligence

When facilitating the purchase of a business through an escrow company, ensure that the escrow company submits a request for the tax and fee clearance on your behalf before the close of escrow. Conduct thorough due diligence on the business’s tax history, particularly if the business operates in multiple locations, as tax obligations may vary across sites and can include any assumed indebtedness.

5. Get Separate Tax Clearances for Multiple Locations

Generally, tax liability is limited to the specific business location from which the assets were acquired. However, if you are purchasing more than one location or a portion of the business’s multiple locations, make sure to request separate tax and fee clearances for each site. A
single clearance may not protect you from liabilities tied to other locations not acquired in the transaction.

Successor liability is a critical issue that should not be overlooked during any business acquisition in California. By understanding the risks and taking proactive steps, such as obtaining a tax clearance certificate and conducting proper due diligence, buyers can significantly minimize their exposure to unexpected tax liabilities. For any questions or concerns regarding CDTFA successor liability, reach out
for professional legal advice to ensure your rights and assets are fully protected.