Do SaaS Companies Afford to Ignore Sales taxes and VAT? -
One of the things I've observed while working is the widespread tendency for SaaS as well as software firms to ignore transaction-related taxes (sales taxes tax, VAT, GST etc. ).
And I get it.
Taxes on sales, VAT and GST are complicated, confusing and not something leaders of software want to devote their time on.
However, it is important to know that ignoring transaction-related taxes has risks well beyond paying certain back taxes later in the near future.
In one of my chats with the Global Tax Director of's Rachel Harding, the most knowledgeable person I have on the subject She told me:
- 40% interest and penalties she's seen software companies accrue in the event of ignoring state sales tax requirements.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
Plus many plus.
So to answer our own question: No it is not a good idea to ignore the VAT, sales as well as GST taxes.
In this article, we cover five points SaaS businesses need to know about taxes. The majority of the information is derived from my discussions with Rachel. Below, you will be able to watch two of our talks for more details.
Five Factors SaaS Companies Need to Understand Concerning Sales Taxes
1. VAT, Sales and GST Taxes Can Affect SaaS Valuations
In the time that Rachel was on the group of tax specialists for mergers and acquisitions for small software companies, she saw million-dollar purchase price changes as a result from tax compliance issues.
"If you're considering any form of ownership change, majority or minor investment, they would like to know more about the company's operations," Rachel explained. "They are going to examine all of your procedures, like are you aware of where your goods are taxable? Are you watching these rules, collecting and remitting? Are you compliant? Since if you're not, the buyer will want you to fix the issue before buying it, or they'll just dock the purchase price."
2. If You Do It Right If You Do It Right, You Don't Have to Pay Anything Extra
"If you're doing it correctly, technically, it's net-zero to you." Rachel explained.
The sales tax is a consumptive tax -- a tax on the consumer, not your company. You shouldn't have to be paying out of pocket. It's up to you to take the taxes on the client's behalf and then pay it back to the right government agency. This is a buyer's responsibility and a seller's responsibility.
"It's the moment you've done the wrong thing that it's an expense and liability on your balance report. In the event that you don't, you're unlikely be able to charge a sales tax two years after the tax was due. Therefore, it's completely paid for out of pocket."
3. Consumption Taxes Calculated based on the Place for the Purchaser, not the location of the seller.
Sales tax is a complicated issue (especially those in that of the U.S.), but generally, what you need to know is that sales taxes are taken into account where the product is realized (aka the place where your customer is located). The tax isn't calculated based on your location, or the location of your company's headquarters.
In practice, the most relevant data used to determine the source of sales is the invoice number as well as the computer's 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 systems actually tax SaaS. In the year 2018, if you've got enough taxable sales in a zone that exceeds the limit, then you're considered to be in economic connection (a special shout-out to South Dakota v. Wayfair for the idea! ).
A sales threshold refers to the quantity of sales that you have in a specific jurisdiction before you have to file taxes. Every tax area (whether it's on a territorial, state or even a national at a global level) has unique ways of defining the threshold.
4. The Tax Laws and Regulations have dramatically changed over the past 10 Years
Sales taxes, VAT, and various other taxation related to transactions have seen a significant change during the past 10 years. Certain adjustments are more crucial than others, and they have altered the landscape entirely.
2015. EU Tax Collection Requirements From Non-EU Software Companies
On January 1, 2015 The EU has begun requiring software providers to collect and pay VAT according to the location of the purchaser rather than the location of the seller's company or employees.
Rates for VAT are decided by each country. This means that governments are accountable for keeping track of the changes in these rates at an individual level.
2018: U.S. Affirms That States May Collect Sales Taxes From Non-Resident Businesses
In 2018 in 2018, The U.S. Supreme Court ruled that states can impose sales tax on purchases made through sellers located outside the state (including sellers on the internet) and even when 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 article since now nonresidents and businesses of all sizes must know about sales tax and the way it is applied.)
Within the U.S., sales tax laws vary from state to state. Florida and California do not require collection of sales taxes on SaaS subscriptions. But New York and Pennsylvania do.
In the year 2020 Massachusetts reclassified SaaS costs as "personal tangible property" which means SaaS subscriptions now are sold with sales tax within the state.
In our interview, Rachel offers other examples of how tax laws are evolving to SaaS enterprises around the world:
"We have seen, across the world, nations making rules specifically targeting companies that are not resident in the country and provide digital goods and services. There are some that have a limit for sales while some states that each dollar is taxable."
5. Global Consumption Taxes Are Getting More Complex
New tax mandates are in the process of being enacted that directly affect SaaS. In the near future, in various all over the world, SaaS companies running digital platforms could have to declare the sellers on their platform.
What is the reason tax laws are becoming more complicated?
Countries know they're losing taxes on sales made online which software firms aren't revealing.
In the process, they're looking for new methods to trace the flow of cash within their state or nation and to enforce the collecting.
The 4 Methods SaaS Companies Can Manage Sales Taxes and VAT
Then how can SaaS companies figure out all the taxes they need to withhold and remit around the world?
There are four approaches that we see SaaS companies employ to satisfy the tax obligation related to transactional taxes:
1. Do not ignore It
In this piece, delaying taxes on sales is a popular practice -- but it could leave your business liable for years of back taxes, fees, and penalties. The time frame in which this strategy could be effective is waning. While online shopping continues to expand, so does the drive and ability to control it.
2. Do It Themselves
Tax preparation on your own is a good option for companies that have the resources to manage the tax burden with an internal team.
But it's not as easy to integrate an automated tax tool into your sales software.
SaaS companies also need to consider:
- Making sure your data is clean and accessible.
- Understanding what's taxable and the charges to be charged.
- Checking tax thresholds for the time to determine the deadlines to pay taxes as well as file tax returns.
- Paying the right amount and submitting returns by the deadline in all tax authorities where you are required to. It could be a monthly, quarterly, or annually.
- Staying informed about changes in tax laws and regulations.
- Responding to inquiries and notices from tax officials. Do they appear to be phishing or is it actionable?
It can be a burden for a finance department without knowledge of technology and may cause discontent and turnover.
3. Hire an Accounting Firm
When you decide to outsource your tax obligations it means that there's lesser internal resources to be utilized however it will be more expensive. In contrast to a custom strategy, hiring an accounting company typically means that they'll follow a more conservative strategy and ensure compliance to the maximum extent regardless of whether you'd prefer an approach that is more tailored.
It's an insight that only an inside tax professional could provide -- one that is based on understanding the business and its tax strategies, 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 merchant of record for the transactions you make on your site and are responsible for collecting taxes and remitting them on your behalf. It doesn't matter if you're trying to deal with reduced tax rates, customized taxes, tax-exempt transactions B2C or B2B , everything is handled by us.
The merchant of record is also at your side if any tax audits or inquires come up. If an audit happens then we step in and assume the responsibility and allow you to concentrate on building and expanding your SaaS company.
What's the best solution for Your Company?
It's possible that this all seems too overwhelming, but the worst option is nothing.
In the words of Rachel put it, "I can never promise that you will or won't receive an audit. But what can I can assure you is that the smallest steps now could make you a better candidate for more brighter and better future."
To figure out what's best for your company it is recommended to evaluate the resources available and the options.
"It's really knowing the business, your footprint, global tax regulations (duh) as well as the risks you're willing accept."
Watch My Full Interviews with Rachel Harding
Part One: The Reasons SaaS Companies Can't Afford to not pay sales tax
Part Two: What Stricter Tax Laws will Mean for SaaS
