Bulk sales tax trap
NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided. The author, David Tait, now deceased, was a longtime and well know appraiser of automobile dealership assets.
In California, when a California-located automobile dealership is being acquired and the pending transaction is an asset purchase, generally, the buy-sell agreement that is drawn up specifies that the transaction be based on the fair market value in continued use in place (FMV) of the furniture, fixtures, equipment, signs, special tooling and perhaps leasehold improvements. When engaging the services of an appraiser to provide a detailed listing and value of the furniture, fixtures, and equipment of a California located automobile dealership, it is important for the buyer to request a separate bulk sales tax valuation be prepared to insure that the calculation of the bulk sales tax obligation will be based on the actual amount of the transaction that is subject to this tax and not upon the FMV generally spelled out in the buyer’s and seller’s buy/sell agreement.
The commonly recognized definition of FMV is the estimated amount of money that may be reasonably expected for a property in exchange between a willing buyer and a willing seller with equity to both, neither being under any compulsion to buy or sell and both fully aware of all relevant facts. A significant fact is the intent of the principals to buy and sell the assembled assets of a franchised automobile dealership.
Acquiring an existing, operating automobile dealership involves more than just acquiring the individual assets comprising the dealership facility. There are substantial turnkey costs associated with the transaction. The turnkey costs encompass plant design and layout, assemblage, installation and testing. FMV also includes California and local sales taxes, as applicable. None of these turnkey costs is subject to the bulk sales tax rule. The purpose of this article is to alert buyers and sellers to this fact and to what the buyer can do to avoid over paying the bulk sales tax as it is likely to be a very expensive error.
When calculating the amount of the bulk sales tax to be paid to the State of California, all too frequently the buyer bases the amount of the bulk sales tax on the FMV estimated for the acquisition of the dealership’s assets. This is incorrect because a significant component of FMV consists of turnkey costs that are not subject to sales tax. Let’s take a look at the various components that make up FMV.
The foundation or starting component of FMV is the prevailing used market range for the specific item in question. As an illustration, we’ll use an aboveground hoist.
Although the manufacturer, age, condition and capacity of an aboveground hoist will directly affect the prevailing used value range, for the purpose at hand a fairly typical aboveground hoist may command between $1,100 and $1,500 used. At this point the element of sales tax would be added to the concluded base value. Then, the appraiser has to consider the elements associated with the fact that the example hoist is but one of several installed and in use at the dealership together with all the other sundry shop furniture, tools and equipment. The appraiser calculates an appropriate factor (usually expressed as a percentage) to cover the assemblage, installation, design and layout elements. These associated elements might bring the fair market value in continued use in place of the example hoist to something closer to $1,800 to $2,000. An air compressor system is another item requiring significant assemblage and installation elements. As an example, for an air compressor system with a FMV of $6,800, there may only be about $3,800 subject to sales tax. This concept and those differences carry over to office furniture, fixtures, equipment, signs, etc. While the individual value differences might not be as great as the foregoing two examples, cumulatively the differences generated by stripping out of FMV those elements not subject to bulk sales tax adds up.
In a couple of fairly recent auto dealership sales where my firm appraised the equipment, both the buyer and the seller were provided with our opinion of the FMV for the purpose of buying and selling the dealership. The buyer was also provided with our opinion of the amount of the FMV that is subject to the bulk sales tax rule. Each opinion was presented in its own appraisal report.
So that the reader may obtain a clearer idea of the substantial difference between the two valuations, a couple of recent examples are cited.
In one case the assembled FMV came to about $230,000. Of this amount only about $74,000 was subject to the bulk sales tax rule. The buyer’s savings was about $12,500 in potential bulk sales taxes.
In another matter, the buyer’s sales tax saving was about $10,700. The buy/sell appraisal indicated a FMV of $249,700. The amount of the FMV subject to sales tax was, however, $116,400. As the reader can readily see, the potential to overpay California’s bulk sales tax involves real money.
This article was written in 2005.