Voluntary information proves to be a useful tool in the tax liability discussion

In an M&A transaction, the buyer and seller must determine how best to deal with unknown or unresolved government tax liabilities resulting from failure to file tax returns and pay taxes in jurisdictions where the company has a connection. This issue has arisen following the decision of the US Supreme Court in South Dakota vs. Wayfair States allow sales tax to be levied on businesses without a physical presence in the jurisdiction.

Addressing government tax risks through a voluntary disclosure agreement may be a desirable avenue, since a VDA typically limits the lookback period to three to five years and reduces or eliminates lookback period penalties. This insight discusses how parties approach VDAs in the context of mergers and acquisitions.

Overview of the VDA process

The VDA process is pretty simple. Outside consultants may work anonymously with a tax authority during most or all of the negotiation phase, or a client may contact state tax authorities directly. The client then enters into a non-negotiable agreement provided by the tax authority and files the appropriate tax returns for the relevant period(s).

Alignment of seller and buyer

A seller with pre-closing tax exemption obligations is often reluctant to apply for a VDA. A seller might be concerned that a buyer will be too willing to admit to tax liability issues due to the buyer’s economic indifference in resolving a VDA. In practice, however, acceptance of large linkages by the buyer would result in higher post-closing operational costs in the form of an increased tax liability. In addition, if a seller is not or becomes not creditworthy, the buyer has no option for reclaim and must make the VDA payments themselves.

A seller can view the VDA process as an increase in their tax exemption obligation. This view is often confused. When a buyer intends to begin filing tax returns in a state, a seller’s failure to previously file required tax returns there becomes apparent. A VDA is a cost-effective solution to limit seller risk by compounding unpaid taxes, penalties, and interest. Ultimately, a buyer and seller should be reconciled with respect to a VDA process even if a seller has granted a tax exemption prior to completion.

VDA Mechanics in the sales contract

In the absence of a specific provision for VDAs, the VDA process is typically governed by amending the tax return provision in a sales contract. A buyer concerned about an unresolved governmental tax obligation should carefully negotiate the amending provision in the absence of a VDA provision.

VDA provisions in a sales contract should specify who controls the process; what role, if any, the counterparty has; and the interaction between VDA-related payments and compensation provisions.

Common Negotiation Areas

Introduction: A buyer will, at its discretion, request the ability to initiate a VDA process, while a seller may wish to negotiate consent rights to initiate a VDA process. Although this provision is heavily negotiated in a sales contract, ultimately both sides agree and should be accessible to VDAs for the reasons outlined above.

Control: Negotiations for control of the VDA process are usually the most contentious. The VDA process is backward-looking by nature. As such, a seller will view the proceeding predominantly as a seller’s affair – particularly as the seller will bear the tax burden and potential third party consulting costs of the proceeding. A buyer, on the other hand, would like to have full control of the processes, since he normally owns the company at the time the VDA is implemented. At a minimum, a seller will typically ask to review and comment on all VDA submissions. A creditworthy seller may require that the buyer include the seller’s reasonable comments in the VDA submissions, or obtain a right of consent.

Duration and time: A seller often wants finality and certainty about their historical tax obligations. Accordingly, a seller will negotiate to limit the duration of the VDA process. Outside consultants familiar with the VDA process in a specific jurisdiction can offer advice on a realistic timeframe. Because a VDA does not typically reduce the interest owed, all parties should want to begin the process as soon as possible. Sometimes the process begins before closing a deal. This is often an efficient way forward, but makes the decision about who should drive the process more nuanced.

Compensation Policy: Often a seller will try to limit their liability by setting an overall dollar limit or by only indemnifying certain jurisdictions. When negotiating a cap (and the level of compensation in general), a buyer should attempt to ensure that the cap covers third-party costs incurred in connection with obtaining the VDA. These costs can be up to the amount due to the state tax authority under the agreement.

In addition, the creditworthiness of the seller should not be ignored. For example, the seller may be individuals or a private equity fund near the end of its life cycle. A trust account is often appropriate for VDA-related liability; The liability becomes known in a relatively short time (compared to, for example, the risk of the federal income tax audit) and the amount of liability and third-party costs can be estimated. Because this indemnity could be longer owed than general purchase agreement indemnity, and because the amount is more predictable than general indemnity, the parties should consider a separate VDA-related escrow.

role of due diligence

Tax Due Diligence informs the VDA process. The due diligence will enable the parties to estimate any potential unpaid state tax liability, which can be used to determine what cap, if any, is appropriate, whether the cap should be imposed from state to state, and the amount of any escrow. A buyer should also confirm whether the carefully identified states reflect all state tax charges or whether there are other state tax charges (whether material or not) that have not been listed. If a self-disclosure materially underestimates tax liability, it can render the agreement non-binding and allow the state to look back at all prior periods.


Although heavily negotiated in sales contracts, a VDA is beneficial to both buyers and sellers. By emphasizing the extent to which the parties agree, a buyer and seller may be able to negotiate more efficiently to mitigate the overall tax liability.

This article does not necessarily represent the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Information about the author

Katharine A. Funkhouser is a senior managing associate at Sidley Austin LLP. She advises clients on a variety of federal income tax planning issues.

Tara M Lancaster is a partner at Sidley Austin LLP. She represents private equity sponsors and corporate clients on federal income tax matters covering a wide range of international and domestic transactions.

Richard M Silverman is a partner at Sidley Austin LLP. His practice focuses primarily on tax issues arising from structured finance and securitization transactions, as well as insolvency and restructuring matters.

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