Can SaaS Companies Ignore Sales Taxes and VAT in 2022? -
One of the things I've observed while working is that it's common for SaaS and software companies to not pay transaction-related taxes (sales taxes, VAT, GST, and so on. ).
And I get it.
VAT, sales taxes, and GST can be confusing, complicated, and not what software executives want to devote their time on.
However, it is important to consider that delaying tax-related transactions can lead to a risk that goes beyond the payment of certain back taxes later in the near future.
I had a chat with the Global Tax Director Rachel Harding, the most knowledgeable person I've met about this topic.
I asked her about:
- 40% penalties and interest she's seen software companies accrue when they've ignored taxes on sales in the state.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
And much plus.
To answer our own question: no it isn't a good idea to ignore tax obligations in 2022.
In this piece, we cover three things SaaS companies need to understand regarding taxes. The majority of the content is derived from my discussion with Rachel who you can watch the entire recording of our chat if you want to hear every word she has to say.
3 Important Things SaaS Companies Need to Understand About Sales Taxes
1. Sales Taxes Are Calculated Based upon the Place of Residence that the buyer is located, Not the Seller
Taxes on sales are a bit complicated (especially in places like that of the U.S.), but in general, the thing to be aware of is that sales tax is taken into account where the item is consumed (aka where your customer is). It is not dependent on where you are or the place of your company's headquarters.
In practice, the most meaningful data for sourcing sales is the invoice number as well as the computer's IP address. Like the title suggests, SaaS is taxed the same way as items, not as services, meaning only 20 of the 45 U.S. states that have sales tax regimes have tax rates that tax SaaS. Since the year 2018, if you've got the amount of taxable sales in your zone that exceeds the threshold, you will be considered to be in economic cross-border nexus (a big shoutout for South Dakota v. Wayfair for this idea! ).
A sales threshold is the number of sales you can make in a particular area before having to pay taxes. Every tax area (whether it's at a national, state, territory, or country at a global level) offers its own method of delineating an appropriate threshold.
2. The Tax Laws and Regulations have Changed Dramatically in the Last 10 years
Sales taxes, VAT, and other transaction-related taxes have been undergoing significant changes in the past ten years. Some changes are more important than others and have changed the tax landscape completely.
Two historic changes comprise:
- On January 1, 2015 The EU has begun requiring software providers to collect VAT and to remit it based on the location of the purchaser rather than the address of the company's employees or of its headquarters.
- In 2018 in 2018, The U.S. Supreme Court ruled that states may charge sales tax on purchases made by sellers outside of the state (including online sellers), even if the seller doesn't have an actual presence in the state that taxes it ( South Dakota v. Wayfair, Inc.). (A.k.a. this is the main reason why we write this post is because now, nonresidents as well as small-sized businesses must be aware of sales tax and the way it is applied.)
If SaaS is tax-deductible has changed in a variety of areas as well.
Within the U.S., Florida and California do not require the collection of sales taxes on SaaS subscriptions. But New York and Pennsylvania do.
Massachusetts didn't require sales tax collection for SaaS. In 2020, however, the state classified SaaS charges in the category of "personal tangible property," meaning SaaS subscriptions are now in the tax bracket of sales taxes in the state.
These changes aren't only happening in the U.S.
In the interview, Rachel offers several examples of the way in which taxes are evolving for SaaS companies around the world.
The point isn't that each SaaS chief executive or founder needs to be an expert in taxation -- far from it.
The point is that you must be aware enough to care about doing it right and finding an accountant you can be confident in.
3. If You've Done It Correctly There's no reason to owe anything Additional
"If you do it right, technically, it's net-zero for you." Rachel explained.
Sales tax is a consumption tax -- a tax on the customer, not your company. This shouldn't be a tax you're spending money on. It's up to you to take the sales tax on the customer's behalf -- and then pay it back to the right public agency. It's a buyer's liability, but a seller's obligation.
"It's when you're doing something wrong that it becomes an expense , and even a liability on your balance account. Feasibly, you're not going be able to charge a sales tax two years after the tax was due. So then it's all paid for out of pocket."
The 4 Ways SaaS Companies Can Manage Sales Taxes and VAT
So how do SaaS companies figure out all the taxes they must pay and withhold around the world?
Four approaches we have observed SaaS businesses employ to meet their tax obligations related to transactions:
1. Do not ignore It
As we've described in this article, ignoring sales taxes is a very frequent practice, but it could leave your company liable for many years of tax back as well as penalties, charges, and fees. The days where this approach will work are waning. As online commerce continues to expand, so does the drive and ability to regulate it.
2. They'll do it themselves
Making your taxes yourself is an option that works well for larger companies with enough resources to handle efficiently with an internal team.
It's just not as straightforward as integrating an automated tax tool into your sales platform.
SaaS firms also must consider:
- Make sure that your data is safe and easily accessible.
- Learning about what's tax-deductible and what charges to be charged.
- Checking tax thresholds for the time to determine where you'll need to remit taxes and submit tax return.
- Remitting the correct amounts and timely filing tax returns in all tax authorities where you are required to. It could be a monthly, quarterly, or every year.
- Staying informed about the latest tax law and rules.
- Responding to notices and inquiries by tax authorities. Is it phishing, or can it be taken action?
It can be a burden for finance departments that do not have the technical know-how and can lead to resentment as well as turnover.
3. Hire an Accounting Firm
When you decide to outsource your tax obligations as a result, you'll have fewer internal resources needed, but it's going to be more expensive. Instead of a custom approach, hiring an accounting firm usually means they'll take a conservative approach with maximum compliance -- even though you would prefer something more customized.
There's a perspective that really only an inside tax professional can provide -- one which requires a thorough understanding of the company, its strategies, tax legislation, and how they all intersect.
4. Utilize 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 and remitting taxes for you. Whether you're trying to manage reduced tax rates, customized taxation, tax-exempt transactions B2C or B2B -everything will be handled by.
A merchant of record is also at your side if there are tax audits or questions that come up. If an audit happens then we step in and assist you to ensure that you concentrate on building and growing your SaaS company.
What's the Best Solution for Your Company?
Perhaps this seems over the top, but the best option is nothing.
According to Rachel put it, "I can never promise that you won't be audited. What I can say is that a few steps now could make you a better candidate for much brighter future."
For determining what's the most effective for your company it is recommended to evaluate your resources and your alternatives.
"It's all about knowing your business, your footprint, global tax regulations (duh) and the risks you're willing accept."
