One of the things I’ve learned while working at FastSpring is how common it is for SaaS and software companies to ignore transaction-related taxes (sales taxes, VAT, GST, etc.).
And I get it.
Sales taxes, VAT, and GST are complicated, confusing, and not what software leaders want to spend their time on.
But also, you should know that ignoring transaction-related taxes has risks well beyond paying some back taxes at some time in the future.
During one of my conversations with FastSpring’s Global Tax Director Rachel Harding, the most knowledgeable person I know about this topic, she told me about:
- 40% interest and penalties 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 much more.
So to answer our own question: No, you shouldn’t ignore taxes in 2022.
In this piece, we cover five things SaaS companies need to understand about taxes. Much of it is taken from my conversations with Rachel. Below, you can also stream two of our conversations to hear more.
5 Things SaaS Companies Need to Understand About Sales Taxes
1. Sales, VAT, and GST Taxes Can Affect SaaS Valuations
When Rachel was working on a mergers and acquisitions tax team for small software companies, she saw million-dollar purchase price adjustments as a result of tax noncompliance.
“If you’re looking to have any kind of ownership change, majority or minority investment, people want to look into your company,” Rachel explained. “They are going to look at all your processes, like do you have a handle on where your products are taxable? Are you watching these rules, collecting and remitting? Are you compliant? Because if not, you’ll want you to fix it before they buy it, or they’ll just dock the purchase price.”
2. If You Do It Right, You Shouldn’t Owe Anything Extra
“If you do it right, technically, it’s net-zero to you,” Rachel explained.
Sales tax is a consumption tax — a tax on the consumer, not on your business. It shouldn’t be something you’re paying out of pocket. But it is up to you to collect sales tax on the customer’s behalf — and remit it to the right government agency. It’s a buyer’s liability, but a seller’s obligation.
“It’s when you’re doing it wrong that it becomes an expense and liability on your balance sheet. Feasibly, you’re not going to assess a customer sales tax two years after it was due. So then it’s all out of pocket.”
3. Consumption Taxes Are Calculated Based on the Location of the Buyer, Not the Seller
Sales taxes are complicated (especially in places like the U.S.), but in general, the thing to know is that sales tax is collected where the benefit of the item is consumed (aka where your customer is located). It is not calculated based on your location, or the location of your company’s headquarters.
In practice, the most meaningful data for sourcing sales is the billing and computer IP address. As the name implies, SaaS is taxed similarly to services and not goods, meaning only 20 of 45 U.S. states with sales tax regimes actually tax SaaS. And since 2018, if you have enough taxable sales in a region that exceeds the specified threshold, then you are deemed to have economic nexus (a big shoutout to South Dakota v. Wayfair for this concept!).
A sales threshold is the amount of sales you have in a specific jurisdiction before you have to file taxes. Each tax region (whether it’s on a state, territory, or country level) has unique ways of defining a threshold.
4. Tax Laws and Regulations Have Changed Dramatically in the Last 10 Years
Sales taxes, VAT, and other transaction-related taxes have changed a lot in the past ten years. Some changes are more important than others and have changed the landscape entirely.
2015: EU Requires VAT Collection From Non-EU Software Companies
On January 1, 2015, the EU began requiring software sellers to collect and remit VAT based on the location of the buyer — not the location of the seller’s company or employees.
VAT rates are set by the country, meaning countries are responsible for keeping up with changes to these rates on a country level.
2018: U.S. Votes That States Can Collect Sales Taxes From Non-Resident Businesses
In 2018, the U.S. Supreme Court ruled that states may charge sales tax on purchases made from out-of-state sellers (including online sellers), even if the seller does not have a physical presence in the taxing state (South Dakota v. Wayfair, Inc.). (A.k.a. the reason we are writing this article since now nonresidents and small businesses need to understand sales tax and its application.)
In the U.S., sales tax regulations differ from state to state. Florida and California do not require collection of sales taxes on SaaS subscriptions. But New York and Pennsylvania do.
Just in 2020, Massachusetts reclassified SaaS fees as “personal tangible property,” meaning SaaS subscriptions are now subject to sales taxes within the state.
In our interviews, Rachel offers other examples of how tax laws are changing for SaaS companies around the world:
“We are seeing, all around the globe, countries creating rules that specifically target non-resident businesses providing digital goods and services. Some will have a threshold of sales, some of them say every dollar is taxable.”
5. Global Consumption Taxes Keep Getting More Complicated
New tax mandates are being passed that directly impact SaaS. Very soon, in countries around the world, SaaS companies running digital platforms may be required to report all sellers using their platform.
Why are tax laws getting more complicated?
Countries know they’re losing tax revenue on digital sales that software companies aren’t disclosing.
As a result, they’re finding new ways to track the flow of money in their state or country and enforce collection.
The 4 Ways SaaS Companies Can Manage Sales Taxes and VAT
So how do 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 take to fulfill their obligations for transaction-related taxes:
1. Ignore It
As we’ve described in this article, ignoring sales taxes is a very common approach — yet one that can leave your company liable for years of back taxes, fees, and penalties. The days where this approach can work is shrinking. As online commerce continues to grow, so does the drive and ability to regulate it.
2. Do It Themselves
Doing taxes on your own is a good option for larger companies with the resources to manage it effectively with an in-house team.
But it’s not as easy as plugging an automated tax tool into your sales platform.
SaaS companies also need to think about:
- Making sure your data is clean and accessible.
- Understanding what’s taxable and the rates to charge.
- Monitoring tax thresholds to know where you’ll need to remit taxes and file tax returns.
- Remitting the correct amounts and filing returns on time for all tax jurisdictions where you have an obligation. This can be monthly, quarterly, or annually.
- Keeping up to date about changing tax laws and regulations.
- Responding to notices and inquiries from tax authorities. Are they phishing, or is it actionable?
This can be burdensome for a finance department without technical expertise and cause resentment and turnover.
3. Hire an Accounting Firm
When you outsource your taxes, there are fewer internal resources needed, but it’s going to cost more. And rather than a customized approach, hiring an accounting firm usually means they’ll take a conservative approach with maximum compliance — even if you would prefer something more customized.
There’s a perspective that really only an in-house tax expert can provide — one that requires understanding the business, its strategies, tax laws, and how they all intersect.
4. Use a Merchant of Record (MoR) and Outsource the Liability
A merchant of record is a powerful sales approach that can lessen the strain on company resources and finances.
At FastSpring, we act as the merchant of record for all transactions on your site, making us responsible for collecting and remitting taxes on your behalf. Whether you’re trying to manage reduced tax rates, customized taxation, tax-exempt transactions, B2C or B2B — everything is handled for you.
A merchant of record is also at your side if any tax audits or inquiries come up. If an audit happens, we intervene and take the lead — so you can stay focused on building and growing your SaaS business.
What’s the Best Solution for Your Company?
Maybe this is all overwhelming, but the worst thing you can do is nothing.
As Rachel put it, “I can never promise that you will or won’t get audited. What I can promise is that small actions now can set you up for a much brighter future.”
To figure out what’s best for your company, she recommends assessing your resources and your options.
“It’s really knowing the business, your footprint, global tax laws (duh), and what risks you are willing to take on.”
As a merchant of record, FastSpring collects and remits taxes on your behalf, so you never have to worry about it. Learn more about our tax services.