Do SaaS Companies Ignore Sales Taxes and VAT until 2022? -
One of the things I've learned while working at is how common it is for SaaS as well as software firms to not pay transaction-related taxes (sales taxes such as VAT, GST, etc. ).
And I get it.
Taxes on sales, VAT and GST are complicated, confusing, and not what software executives want to devote their time.
But also, you should consider that delaying tax-related transactions can lead to a risk that goes beyond the payment of some back taxes sometime in the future.
I had a chat with Global Tax Director Rachel Harding, the most knowledgeable person I know about this topic.
She shared with me:
- 40% interest and penalties She's witnessed software companies incur 40% in interest and penalties for not complying with state sales tax requirements.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
And many and more.
In answer to our own question: No, you shouldn't ignore taxes until 2022.
In this post we will discuss three important things SaaS firms must be aware of regarding taxes. The majority of the content is derived from my chat with Rachel as well as you may play the complete recording of our chat for those who want to listen to all her insights.
Three Important Things SaaS Companies Need to Understand Concerning Sales Taxes
1. Sales Taxes are Calculated Based upon the Place of Residence of the Buyer, not the Seller
Sales taxes are complicated (especially those in that of the U.S.), but generally speaking, what's important to be aware of is that sales taxes are paid where the item is consumed (aka the place where your customer is located). It's not calculated based on your location as well as the area of your company's headquarters.
In reality, the most important data to source sales is billing information as well as the computer's IP address. As the name implies, SaaS is taxed the same way as products, but not services, meaning only 20 of the 45 U.S. states that have sales tax regimes actually tax SaaS. In 2018if there are sufficient taxable sales within a area that is greater than the threshold, then you are legally considered to have economic nexus (a big shoutout for South Dakota v. Wayfair to explain this concept! ).
A sales threshold is the quantity of sales that you have in a specific region before you are required to submit taxes. Every tax area (whether it's at a national, state, territory, or country level) has unique ways of defining a threshold.
2. Tax Laws and Regulations Have Significantly changed in the last 10 Years
Sales taxes, VAT, and other transaction-related taxes have seen a significant change during the last 10 years. Certain changes are more significant than others and changed the tax landscape completely.
Two major changes in history are:
- On January 1, 2015, the EU started requiring software vendors to collect and remit VAT based on the location of the buyer and not on the location of the business or its employees.
- In the year 2018 in 2018, The U.S. Supreme Court ruled that states are allowed to charge sales tax on purchases made by sellers outside of the state (including the internet-based sellers), even if the seller doesn't have any physical presence within the state that taxes it ( South Dakota v. Wayfair, Inc.). (A.k.a. the reason we are writing this post is because now, nonresidents and small businesses need to know about sales tax and the way it is applied.)
Whether SaaS is tax-deductible is a subject that has been re-defined in several different areas too.
The U.S., Florida and California don't require collection of sales taxes on SaaS subscriptions. However, New York and Pennsylvania do.
Massachusetts didn't require sales tax collection for SaaS. But in 2020, the state changed its classification of SaaS fees in the category of "personal tangible property" which means SaaS subscriptions are now tax-exempt in the state.
They're not just occurring across the U.S.
In the interview, Rachel offers several examples of tax changes for SaaS companies around the world.
The point isn't that every SaaS founder or CEO has to be an expert in taxation in the least.
It is important to remember that you should be educated enough about tax preparation to be sure you are getting it done right, and also finding a tax partner you can count on.
3. If You Do It Right If You Do It Right, You Don't Have to Pay Anything Additional
"If you're doing things right, technically, it's net-zero for you." Rachel explained.
Sales tax is a consumption tax -- it's a tax on the customer, not your company. You shouldn't have to be paying out of pocket. However, it's the responsibility of you to to collect sales tax on your buyer's behalf, and then pay it back to the right government agency. The buyer is responsible however, a seller's duty.
"It's the moment you're doing it wrong that it's an expense , and even a obligation in your balance report. It's possible, but you're not likely to assess sales tax for two years following the time it was due. So then it's all from your pocket."
The Four Ways SaaS Companies Can Manage Sales Taxes and VAT
Then how can SaaS companies figure out all the taxes they must withhold and remit across the globe?
There are four ways we have observed SaaS companies take to fulfill the tax obligation related to transactional taxes:
1. Don't Pay Attention
We've discussed in this piece, delaying sales taxes is a very common approach -- yet it could leave your business liable for many years of tax back or fees and penalties. The days where this approach can work is shrinking. The pace at which online transactions continue to grow, so will the desire and capability to control it.
2. Self-Help
Doing taxes on your own is a good option for companies that have enough resources to handle efficiently with an internal team.
However, it's not as simple as integrating an automatic tax tool to the sales system you use.
SaaS businesses also have to be thinking about:
- Making sure your data is clean and accessible.
- Knowing what is taxable as well as the rates to charge.
- Monitoring tax thresholds to know the deadlines to pay taxes and file tax returns.
- Remitting the correct amounts and filing returns on time for all tax jurisdictions where you are required to. It could be a monthly, quarterly, or every year.
- Be aware of changing tax laws and regulations.
- Answering inquiries and notices from tax officials. Do they appear to be phishing or are they a legal matter?
This can be burdensome for finance departments that do not have the technical know-how and can lead to resentment as well as turnover.
3. Employ an accounting firm
When you decide to outsource your tax obligations as a result, you'll have fewer internal resources needed, but it's going to be more expensive. And rather than a customized method, using an accounting firm usually means they'll adopt a cautious approach and ensure compliance to the maximum extent -- even if you would prefer something more customized.
It's an insight that only an inside tax professional could provide -- one that requires understanding the business, its strategies, tax regulations, and the ways in which they intersect.
4. Make use of a Merchant of Record (MoR) and outsource the Liability
At , we act as the official merchant for the transactions you make on your site, making us responsible for collecting taxes and remitting them on behalf of you. It doesn't matter if you're looking for the tax rate reduction, custom taxes, tax-exempt transactions B2C or B2B -everything will be handled by.
A merchant of record is also at your side if there are tax audits or questions that are raised. In the event of an audit, we intervene and take the lead -- so you can stay focused on building and growing your SaaS company.
What's the best solution for your company?
Maybe this is all confusing, but the most damaging option is nothing.
In the words of Rachel put it, "I can never promise that you will or won't get audited. The only thing can I can assure you is that small actions taken now will set you up for a much brighter future."
To figure out what's best for your company She suggests analyzing your resources and your options.
"It's all about knowing your business, your footprint, global tax regulations (duh) as well as the risk you're willing to accept."
