Did a reverse triangular merger or the buyer's lack of knowledge eliminate the target corporation's earlier withholding-tax liability?

Subject

Taxpayer is liable for all of Corporation liabilities after a reverse triangular merger

Plain-English summary

Virginia held that the target corporation remained liable for withholding tax incurred before its reverse triangular merger. The target survived as a corporation and became the buyer's subsidiary, so its existing liabilities remained vested in it under Va. Code § 13.1-721 4.

The buyer's lack of knowledge and the former president's contractual warranties did not shift the Department's claim away from the taxpayer. Virginia could potentially assess a responsible corporate officer under Va. Code § 58.1-1813, but doing so would not release the corporation itself.

The penalty also remained. A later merger or change in responsible personnel was not reasonable cause for a failure that occurred before the transaction.

What this means for you

• A reverse triangular merger leaves the target entity—and its tax liabilities—in existence.
• Tax representations and indemnities allocate risk between private parties but do not erase the Department's assessment.
• Officer liability can be an additional collection route, not a substitute for corporate liability.
• Penalty relief must relate to circumstances existing when the tax failure occurred.

Common questions

Q: Did the buyer's ignorance of the tax debt matter?
A: No. The surviving target remained responsible for its liabilities.

Q: Could Virginia pursue the former president?
A: Potentially, if the statutory officer-liability requirements were met, but that would not relieve the corporation.

Q: Did the merger establish reasonable cause for penalty waiver?
A: No. The withholding failure occurred before the merger, and later personnel changes were not reasonable cause.

Citations and references

• Va. Code §§ 58.1-461, 13.1-721 4, 58.1-1813, and 58.1-105.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-141

Original ruling text

July 30, 2008

Re: § 58.1-1821 Application: Withholding Tax

Dear *:

This will reply to your letter in which you seek correction of the withholding tax assessment issued to * (the "Taxpayer") for the period October 2005 through December 2005.

FACTS

In July 2007, a wholly-owned subsidiary of * ("Corporation A") acquired the Taxpayer in a reverse triangular merger. In November 2007, the Department issued an assessment to the Taxpayer for employee income tax that the Taxpayer failed to withhold and remit for the period at issue.

Corporation A contends that the merger agreement contained warranties and representations from the Taxpayer's then president (the "President") to the effect that there were no undisclosed tax liabilities. Corporation A requests that the Department abate the assessment issued to the Taxpayer on equitable grounds and for reasonable cause. In the alternative, Corporation A requests that the Department waive the penalty for reasonable grounds and pursue the President for the Taxpayer's unpaid liabilities.

DETERMINATION

Virginia Code § 58.1-461 requires every employer who pays wages, to employees to deduct and withhold Virginia income tax from the wages. The Taxpayer failed to withhold income tax from its employees and remit it to Virginia.

In a reverse triangular merger, a subsidiary of an acquiring corporation merges into the target corporation. The subsidiary's stock is converted into target corporation stock and the target corporation shareholders receive the merger consideration in exchange for their stock. The result is that the target corporation becomes a subsidiary of the acquiring corporation. In this case, the Taxpayer became a subsidiary of Corporation A, and retained its character as a corporation.

The Taxpayer asserts that because Corporation A was not aware of the withholding liability and not in control of the Taxpayer at the time the merger occurred, the Department should rule that the Taxpayer is not liable for payment of the assessments. However, Virginia Code § 13.1-721 4 states, "All liabilities of each domestic or foreign corporation or eligible entity that is merged into the survivor are vested in the survivor." As such, the Taxpayer remains liable for all of its liabilities after the reverse triangular merger. Accordingly, the outstanding assessment for employer withholding taxes remains an obligation of the Taxpayer.

Based on the warranties and representations made by the President, the Taxpayer asks the Department to forgo pursuing the assessment against the Taxpayer and collect the liability from the President. When a corporation fails or is unable to pay its tax deficiencies, the Department is permitted to assess any corporate officers for a penalty of the amount of the tax evaded, or not paid, collected or accounted for and paid over. See Va. Code § 58.1-1813. Even if the Department were to pursue this avenue of collection, it would not relieve the Taxpayer of the liability.

Finally, in light of the circumstances of this case, the Taxpayer requests the Department waive the penalties assessed. Virginia Code § 58.1-105 grants the Tax Commissioner authority to waive penalty for reasonable cause. A change in a corporation's personnel responsible for remitting appropriate taxes (whether through mergers and acquisitions, retirement, promotion, termination, or resignation) is not considered reasonable cause to waive a penalty. Further, the liability at issue occurred well before the merger. As such, the Taxpayer would have to establish that some event occurred concurrently with the failure to withhold the tax to establish reasonable cause for waiving the penalty.

Accordingly, Corporation A's request for the abatement of the Taxpayer's liability for failing to withhold income tax for the period of October 2005 through December 2005 is denied. A bill with updated interest will be issued shortly. The Taxpayer should remit its payment for the outstanding balance as shown on the revised bill within 30 days from the date of the bill to avoid the accrual of additional interest.

The Code of Virginia sections cited are available on-line at www.tax.virginia.gov. If you have any questions regarding this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2163754535.B