Are SaaS Companies Ignore Sales Taxes and VAT by 2022? -
One thing I've observed while working is that it's common to SaaS as well as software firms to not pay transaction-related taxes (sales taxes tax, VAT, GST etc. ).
And I get it.
VAT, sales taxes, and GST can be confusing, complicated and not something IT leaders would like to invest their time.
But also, you should consider that delaying tax-related transactions has risks well beyond paying certain back taxes sometime in the near future.
I had a chat with the Global Tax Director Rachel Harding, the most knowledgeable person I've met regarding this issue.
She told me about:
- 40% penalty and interest She's witnessed software companies incur 40% in interest and penalties when they've ignored taxes on sales in the state.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
Plus many more.
To answer our own question: no it isn't a good idea to ignore tax obligations until 2022.
In this article, we cover three things SaaS firms must be aware of regarding taxes. Much of it is taken from my discussion with Rachel who you can watch the entire video of our conversation in case you'd like to hear the full range of her thoughts.
Three Important Things SaaS Companies Need to Understand About Sales Taxes
1. Sales Taxes Are Calculated Based on the Location of Buyer Not the Seller
Taxes on sales are a bit complicated (especially in countries like those in the U.S.), but generally, what you need to remember is that sales taxes are collected where the benefit of the item is consumed (aka the location where your client is located). It's not determined based on the location of your business or the place of the headquarters for your business.
The most relevant data used to determine the source of sales is the billing as well as the computer's IP address. The name suggests that SaaS is taxed the same way as products, but not services, meaning only 20 of 45 U.S. states with sales tax systems are actually taxing SaaS. Since 2018if there are enough taxable sales in a zone that exceeds the limit, you're legally considered to have economic cross-border nexus (a huge shout-out to South Dakota v. Wayfair for this idea! ).
A threshold for sales is the number of sales within a certain region before you are required to submit taxes. Each tax region (whether it's on a territorial, state or country level) is unique in defining a threshold.
2. The Tax Laws and Regulations have Changed Dramatically in the Last 10 Years
Sales taxes, VAT as well as other taxes related to transactions have changed a lot in the past ten years. Certain adjustments are more crucial than others, and they have altered the tax landscape completely.
Two historic changes are:
- Since January 1st, 2015 on the 1st of January, 2015, the EU has begun requiring software providers to collect and pay VAT based on the location of the purchaser rather than 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 made from out-of-state sellers (including those selling online), even if the seller does not have an actual presence in the state that taxes it ( South Dakota v. Wayfair, Inc.). (A.k.a. the reason we are writing this article since now nonresidents and businesses of all sizes must be aware of sales tax and the way it is applied.)
Whether SaaS is tax-deductible has changed in many different areas too.
Within the U.S., Florida and California are not required to payment of sales tax on SaaS subscriptions. But New York and Pennsylvania do.
Massachusetts didn't require sales tax collection for SaaS. But in 2020, the state classified SaaS fees as "personal tangible property" which means SaaS subscriptions will be in the tax bracket of sales taxes within the state.
They're not just occurring in the U.S.
In our interview, Rachel offers several examples of the way in which taxes are evolving for SaaS organizations around the world.
It's not that every SaaS founder or CEO needs to be an expert in taxation -- far from it.
It is important to remember that you must be aware enough to take care of doing it right and finding an accountant you can be confident in.
3. If You've Done It Correctly If You Do It Right, You Don't Have to Pay Anything Extra
"If you're doing it correctly technically, the net zero is not a problem for you," Rachel explained.
Tax on sales is a consumption tax -- a tax on the customer, not on your business. It shouldn't be something you're spending money on. It's up to you to take the sales tax on your client's behalf and then pay it back to the appropriate public agency. The buyer is responsible however, a seller's duty.
"It's when you're doing something wrong that it's an expense and obligation in your balance account. Feasibly, you're not going to assess sales tax for two years after the tax was due. Then it's out of pocket."
The 4 Ways SaaS Companies Can Manage Sales Taxes and VAT
Then how can SaaS firms determine the taxes they need to be withheld and pay around the world?
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 article, ignoring sales taxes is a very common approach -- yet one that can leave your company with many years of tax back as well as penalties, charges, and fees. The time frame in which this strategy will work are waning. While online shopping continues to expand, so will the desire and capability to regulate it.
2. Self-Help
Doing taxes on your own is an option that works well for larger companies with enough resources to handle efficiently with an internal team.
But it's not as easy as integrating an automatic tax tool to your sales software.
SaaS businesses also have to think about:
- Ensure that your information is clean and accessible.
- Knowing what is taxable as well as the rate to pay.
- Monitor tax thresholds so you know the deadlines to pay taxes and submit tax returns.
- Remitting the correct amounts and filing returns on time in all tax authorities where there is an obligation. This can be every month, each quarter, or annually.
- Be aware of the latest tax law and rules.
- Responding to notices and inquiries by the tax officials. Do they appear to be phishing or is it actionable?
This could be difficult for finance departments that do not have knowledge of technology and may cause discontent and increased turnover.
3. Employ an accounting firm
When you outsource your taxes it means that there's less internal resources to be utilized and it's likely to cost more. And rather than a customized strategy, employing an accounting firm typically means they'll take a conservative approach that is compliant to the highest degree regardless of whether you would prefer to have a more personalized approach.
There's a perspective that really only an inside tax professional can provide -- one that is based on understanding the business and its tax strategies, laws, and how they all intersect.
4. Use the services of a Merchant of Record (MoR) and outsource the Liability
At , we act as the primary merchant on the transactions you make on your site which means we are accountable to collect and pay taxes on your behalf. If you're looking to handle the tax rate reduction, custom taxation, tax-exempt transactions, B2C, or B2B- it all is handled for you.
Merchants of record are also at your side if there are tax audits or questions that come up. In the event of an audit then we step in and take the lead -- so you can remain focused on developing 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 to do nothing.
As Rachel stated, "I can never promise that you won't get audited. The only thing I can promise is that small actions taken now will make you a better candidate for more brighter and better future."
For determining what's the most effective for your company it is recommended to evaluate the resources available and the alternatives.
"It's essential to know your company's needs and your location, as well as global tax regulations (duh), and what risks you are willing to take on."
