Do SaaS Companies Ignore Sales Taxes and VAT until 2022? -
One thing I've observed while working is how common it is for SaaS as well as software firms to ignore transaction-related taxes (sales taxes, VAT, GST, and so on. ).
And I get it.
Taxes on sales, VAT and GST are complex, confusing and not something IT leaders would like to invest their time.
However, it is important to consider that delaying tax-related transactions could result in the need to pay the tax back at some time to come.
I had a chat with the Global Tax Director Rachel Harding, the most knowledgeable person that I have met about this topic.
She told me about:
- 40% penalties and interest Software companies have incurred 40% interest and penalties in the event of ignoring taxes on sales in the state.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
And there's more.
In answer to the question we asked ourselves: No, you shouldn't ignore taxes until 2022.
In this article we will discuss three important things SaaS firms must be aware of about taxes. The majority of the content is derived from my conversation with Rachel who you can play the complete audio of our discussion if you want to hear every word she has to say.
3 things SaaS Companies Need to Understand About Sales Taxes
1. Sales Taxes are Calculated Based on the location of the Buyer, Not the Seller.
Sales taxes are complicated (especially those in those in the U.S.), but generally, what you need to remember is that sales taxes are taken into account where the item is consumed (aka where your customer is). It's not calculated based on your location or the place of your corporate headquarters.
The most meaningful data for sourcing sales is billing information as well as the computer's IP address. The name suggests that SaaS is taxed in the same way as items, not as services which means that only 20 out of the 45 U.S. states that have sales tax systems actually tax SaaS. Since the year 2018, if you've got enough taxable sales in a zone that exceeds the threshold, then you are deemed to have economic connection (a huge shout-out for South Dakota v. Wayfair for this concept! ).
A threshold for sales is the number of sales you can make in a particular region before you are required to submit taxes. Each tax zone (whether it's at a national, state, territory, or country level) has unique ways of setting the threshold.
2. Tax Laws and Regulations Have dramatically changed over the past 10 Years
Sales taxes, VAT and other transaction-related taxes have seen a significant change in the past ten years. Certain changes are more significant than others and have changed the landscape entirely.
Two significant changes have occurred in the past comprise:
- Since January 1st, 2015 on the 1st of January, 2015, the EU started requiring software vendors to collect and pay VAT based on the location of the buyer and not on the location of the business or its employees.
- In 2018 it was the year that the U.S. Supreme Court ruled that states can impose sales tax on purchases by sellers outside of the state (including online sellers) regardless of whether the seller doesn't have a physical presence in the taxing state ( South Dakota v. Wayfair, Inc.). (A.k.a. this is the main reason why we write this post is because now, nonresidents and small businesses need to be aware of sales tax and the way it is applied.)
If SaaS is tax-deductible has changed in a variety of sectors as well.
In the U.S., Florida and California do not require the tax collection on sales taxes for SaaS subscriptions. But New York and Pennsylvania do.
Massachusetts didn't require sales tax collection for SaaS. In 2020, however, the state reclassified SaaS fees in the category of "personal tangible property," meaning SaaS subscriptions will be tax-exempt in the state.
And these changes aren't just occurring across the U.S.
In our conversation, Rachel offers several examples of how taxes are changing for SaaS companies around the world.
It's not that every SaaS founder or CEO has to be a tax expert -- far from it.
The point is that you should be educated enough to take care of making it the right way and to find an IRS partner that you can be confident in.
3. If You've done it right If You Do It Right, You Don't Have to Pay Anything Additional
"If you do it right technically, then it's zero to you," Rachel explained.
Sales tax is a consumption tax -- a tax to the consumer and not your company. You shouldn't have to be spending money on. However, it's the responsibility of you to collect sales tax on the client's behalf and then pay it back to the appropriate public agency. It's a buyer's liability and a seller's responsibility.
"It's when you're doing something wrong that it becomes an expense , and even a charge on your balance account. It's possible, but you're not likely to assess a customer sales tax for two years after the tax was due. So then it's all out of pocket."
4 Strategies SaaS Companies Can Manage Sales Taxes and VAT
How do SaaS businesses determine all the tax they have to pay and withhold across the globe?
Four approaches we have observed SaaS businesses employ to meet the tax obligation related to transactional taxes:
1. Do not ignore It
We've discussed in this post, not paying sales tax is an extremely frequent practice, but it can make your company liable for many years of tax back or fees and penalties. The time frame in which this strategy can work is shrinking. While online shopping continues to grow, so will the desire and capability to manage it.
2. Self-Help
Doing taxes on your own is a good option in larger businesses that have the capacity to do the tax burden with an internal team.
However, it's not as simple as integrating an automatic tax tool to your sales platform.
SaaS firms also must be thinking about:
- Making sure your data are safe and easy to access.
- Understanding what's taxable and the rates to charge.
- Checking tax thresholds for the time to determine the deadlines to pay taxes and submit tax return.
- Remitting the correct amounts and filing returns on time to all tax-related jurisdictions in which you are required to. It could be a every month, each quarter, or annually.
- Keeping up to date about changes in tax laws and regulations.
- Responding to notices and inquiries by the tax authorities. Is it phishing, or are they a legal matter?
This could be difficult for a finance department without knowledge of technology and may cause discontent and increased turnover.
3. Hire an Accounting Firm
When you decide to outsource your tax obligations it means that there's fewer internal resources needed and it's likely to cost more. Instead of a custom method, using an accounting firm typically means they'll take a conservative approach and ensure compliance to the maximum extent -- even if you'd like to have a more personalized approach.
The perspective is one that only an in-house tax expert can provide -- one that is based on understanding the business strategy, the tax laws, and how they are all interconnected.
4. Make use of the services of a Merchant of Record (MoR) and Outsource the Liability
As a company, we are the primary merchant on all transactions on your site which means we are accountable for collecting and remitting taxes for you. If you're looking to handle lower tax rates, custom taxation, tax-exempt transactions, B2C or B2B -everything is taken care of for you.
The merchant of record is also at your side if any tax audits or inquires come up. When an audit occurs then we step in and assist you -- so you can remain focused on developing and growing your SaaS business.
What's the best solution for Your Company?
It's possible that this all seems too overwhelming, but the worst choice is nothing.
As Rachel said, "I can never promise that you won't be audited. The only thing do I can promise is that small actions taken now will make you a better candidate for much brighter future."
For determining what's the most effective for your company She suggests analyzing the resources available and the alternatives.
"It's all about knowing your business, your footprint, global tax laws (duh), and what risks you are willing to be willing to take."
