Unlike state and local income taxes, which generally “piggyback” on the federal rules, there is a core disconnect between the income tax rules and those of the sales tax. In New York, the State sales tax was adopted in 1965, modeled after a 1934 New York City sales tax. As such, the tax, and its basic underpinnings, stems from an entirely different root than that of the federal, state and local income taxes. The sales tax, and its sibling, the use tax, are seemingly clear-cut and simplistic. However, in interpretation and administration, the sales and use taxes are among the most complex and arcane in existence today. An entirely different set of criteria applies to the sales and use tax definition than for other taxes. A person who is subject to the sales tax, and deemed a resident for purposes of that tax, may not be deemed a resident for income tax purposes. Transactions which are recognized under the income tax may not be recognized for sales and use purposes, or vice versa. In many respects, the New York State and local sales taxes are more complex than the equivalent state, local or federal income taxes in application and administration. Without doubt, the results of a transaction for sales and use tax purposes are more difficult to predict than under the income tax. Further, while it is generally the substance of a transaction which controls its income tax consequences, the sales tax is much more dependent upon the form it takes. The New York Courts have historically validated the use of form-based step transactions to manipulate the sales tax effect of a transaction without regard to their economic substance. If the form fits the exemption, neither “substance over form” or “step transaction doctrine” will be imposed to change it.
For example, if one buys the assets of a corporation, sales and/or use tax will be due on every taxable asset acquired even if the transaction is a tax free reorganization for income tax purposes. Buy the stock of the corporation and then liquidate it to get the assets you desire and no tax is due at all. Thus a merger or consolidation could be tax free in one form and taxable in another with identical economic and substantive effect.
It is the interaction of the broad definition of sale and use, the limitation of the tax to tangible property only, and a unique exemption for corporate and partnership transactions that gives rise to the immense danger of creating sales tax liabilities in the course of these transactions. However, the corollary also applies. The differences in income and sales tax treatment present significant potential to reduce or eliminate sales taxes otherwise payable on reorganization and acquisition transactions. Thus it is critical to include state sales and use tax planning into the mix whenever a corporate acquisition or disposition is contemplated.
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