Do SaaS Companies Afford to Ignore Sales Taxes and VAT? -
One of the things I've discovered while working is the widespread tendency to SaaS as well as software firms to ignore transaction-related taxes (sales taxes such as VAT, GST, etc. ).
And I get it.
Sales taxes, VAT, and GST are complicated, confusing and not something IT leaders would like to invest their time on.
But also, you should know that ignoring transaction-related taxes has risks well beyond paying some back taxes later in the future.
During one of my conversations with the Director of Global Tax Rachel Harding, the most knowledgeable person I have on the subject, she told me about:
- 40% penalties and interest she's seen software companies accrue when they've ignored state sales tax requirements.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
And there's and more.
So to answer our own question: No You shouldn't forget about the VAT, sales and GST taxes.
In this article this article, we discuss five important aspects SaaS companies need to understand regarding taxes. A lot of this information comes from my conversations with Rachel. Below, you can also stream two of our conversations to learn more.
5 Things SaaS Companies Need to Understand About Sales Taxes
1. VAT, Sales and GST Taxes can affect SaaS's Value
When Rachel was working on a team of mergers and acquisitions tax experts for small software companies she witnessed million-dollar price adjustments as a result of tax noncompliance.
"If you're planning to make any kind of ownership change, majority or minority investment, investors are going to investigate the company's operations," Rachel explained. "They are going to look at all your processes such as do you have a handle on where your products are taxable? Are you adhering to these rules, collecting and remitting? Are you compliant? Since if you're not, the buyer will be required to rectify the issue before buying it, or they'll just reduce the price of the purchase."
2. If You've Done It Correctly If You Do It Right, You Don't Have to Pay Anything Additional
"If you've done it the right way, technically, it's net-zero to you." Rachel explained.
The sales tax is a consumptive tax -- a tax on the customer, not your company. It shouldn't be something you're paying out of pocket. However, it's the responsibility of you to take the taxes on the buyer's behalf, and then pay it back to the appropriate department of government. The buyer is responsible and a seller's responsibility.
"It's when you're doing it wrong that it becomes an expense and liability on your balance report. It's possible, but you're not likely to assess sales tax two years after the tax was due. Then it's paid for out of pocket."
3. Consumption Taxes are Calculated based on the Place of the Buyer, not the Seller.
Sales tax is a complicated issue (especially in places like those in the U.S.), but generally, what you need to remember is that sales tax is paid where the item is realized (aka where your customer is located). The tax isn't determined based on the location of your business or the place of your corporate headquarters.
The most meaningful data for sourcing sales is the billing and computer IP address. Like the title suggests, SaaS is taxed in the same way as products, but not services, meaning only 20 of the 45 U.S. states with sales tax laws are actually taxing SaaS. Since 2018, if you have enough taxable sales in a zone that exceeds the limit, then you're considered to be in economic nexus (a big shoutout for South Dakota v. Wayfair for this concept! ).
A sales threshold refers to the amount of sales within a certain area before having to file taxes. Every tax area (whether it's at a national, territorial, state or country level) offers its own method of setting the threshold.
4. Tax Laws and Rules have dramatically changed over the past 10 years
Sales taxes, VAT and various other taxation related to transactions have seen a significant change over the last ten years. Certain changes are more significant than others and have changed the landscape entirely.
2015: EU Requires VAT Collection From Non-EU Software Companies
Since January 1st, 2015 on the 1st of January, 2015, the EU has begun requiring software providers to collect and remit VAT in accordance with the place of the purchaser rather than the address of the seller's company or employees.
The VAT rates are determined by the country, meaning the country is responsible to keep up with any adjustments to these rates on the level of their country.
2018: U.S. The Senate has voted that states can collect Sales Taxes From Non-Resident Businesses
In 2018 it was the year that the U.S. Supreme Court ruled that states may charge sales tax for purchases by sellers outside of the state (including sellers on the internet), even if the seller is not located in a physical presence in the state that taxes it ( South Dakota v. Wayfair, Inc.). (A.k.a. the reason we are writing this piece is that non-residents and businesses of all sizes must know about sales tax and its application.)
Within the U.S., sales tax regulations differ from state to state. Florida and California don't require the collection of sales taxes on SaaS subscriptions. However, New York and Pennsylvania do.
Just in 2020, Massachusetts reclassified SaaS fees to "personal tangible property" which means SaaS subscriptions are now subject to sales taxes in the state.
In our conversations, Rachel offers other examples of tax law shifting for SaaS enterprises around the world:
"We have seen, over the globe, governments creating rules that specifically target companies that are not resident in the country and provide digital goods and services. Some will have a threshold for sales while some states that each dollar counts as tax-deductible."
5. Global Consumption Taxes Keep Getting More Complicated
Tax laws are currently being passed that directly impact SaaS. Soon, in many different countries, SaaS companies running digital platforms could be required to report every seller that uses their platform.
Why are tax laws getting more complex?
Countries know they're losing the tax revenues from digital sales which software firms aren't revealing.
This is why they're attempting to find new ways to track the flow of cash in their states or across the country, and also enforce their collection.
The 4 Ways SaaS Companies Can Manage Sales Taxes and VAT
Then how can SaaS businesses determine all the taxes they must withhold and remit all over the world?
Four approaches we see SaaS companies take to fulfill the tax obligation related to transactional taxes:
1. Don't Pay Attention
In this piece, delaying taxes on sales is a frequent practice, but it could leave your company liable for decades of unpaid taxes or fees and penalties. The period in which this method can work is shrinking. The pace at which online transactions continue to expand, so is the motivation and capacity to control it.
2. Do It Themselves
Tax preparation on your own can be a great option for companies that have enough resources to handle it effectively with an in-house team.
But it's not as easy as plugging an automatic tax tool to your sales platform.
SaaS businesses also have to be thinking about:
- Make sure that your data are safe and easy to access.
- Knowing what is taxable as well as the rate to pay.
- Monitor tax thresholds so you know the deadlines to pay taxes as well as file tax returns.
- Making sure you pay the proper amount and filing tax returns in time to all tax-related jurisdictions in which there is an obligation. This could be for a month either quarterly, monthly, or annual.
- Keeping up to date about changes in tax laws and regulations.
- Answering inquiries and notices from the tax authorities. Are they phishing, or can it be taken action?
It can be a burden for a finance department without knowledge of technology and may cause discontent as well as turnover.
3. Find an accounting company to hire
When you decide to outsource your tax obligations as a result, you'll have lesser internal resources to be utilized however it will cost more. In contrast to a custom strategy, hiring an accounting company typically means they'll take a conservative approach that is compliant to the highest degree even though you would prefer an approach that is more tailored.
The perspective is one that only an in-house tax expert can provide -- one which requires a thorough understanding of the company and its tax strategies, legislation, and how they intersect.
4. Make use of the services of a Merchant of Record (MoR) and Outsource the Liability
We are the official merchant for the transactions you make on your site, making us responsible for collecting taxes and remitting them on your behalf. If you're looking to handle lower tax rates, custom taxation, tax-exempt transactions B2B or B2C -- everything is managed for you.
Merchants of record are there to assist you if there are tax audits or questions that come up. When an audit occurs We intervene to assist you to ensure that you concentrate on building and growing your SaaS company.
What's the most effective solution for your company?
It's possible that this all seems too overwhelming, but the worst thing you can do is not to take action.
In the words of Rachel put it, "I can never promise that you won't receive an audit. But what I can assure you is that the smallest steps now could set you up for a far brighter prospects in the future."
To figure out what's best for your company She suggests assessing the resources available and the alternatives.
"It's all about knowing your business you operate, the footprint of your business, tax regulations (duh) and the risks you are willing to accept."
Watch My Full Interviews with Rachel Harding
Part One: Why SaaS Companies Can't Afford to ignore Sales Taxes
Part Two: What Stricter Tax Laws Will Mean For SaaS
