Are SaaS Companies Afford to Ignore VAT and Sales Taxes? -
One of the things I've discovered while working is that it's common for SaaS and software firms to ignore transaction-related taxes (sales taxes tax, VAT, GST and so on. ).
And I get it.
Taxes on sales, VAT and GST are complicated, confusing and are not the things leaders of software want to devote their time on.
However, it is important to consider that delaying tax-related transactions has risks well beyond paying some back taxes sometime in the near future.
During one of my conversations with 's Global Tax Director Rachel Harding, my most experienced and knowledgeable source of know about this topic I was told:
- 40% penalty and interest Software companies have incurred 40% interest and penalties in the event of ignoring the sales tax laws of states.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
And there's more.
To answer the question we asked ourselves: no, you shouldn't ignore taxes on sales, VAT as well as GST taxes.
In this post this article, we discuss five important points SaaS businesses need to know regarding taxes. Much of it is taken from my conversations with Rachel. Below, you'll be able to listen to two of our chats for more details.
5 things SaaS Companies Need to Understand About Sales Taxes
1. VAT, Sales taxes on GST and Sales Taxes may affect SaaS Values
When Rachel was working on a group of tax specialists for mergers and acquisitions for small software companies she saw million-dollar purchase price adjustments as a result of tax evasion.
"If you're considering any kind of ownership change, majority or minority investment, people want to look into the company's operations," Rachel explained. "They are going to investigate all the processes and ask questions like, are you aware on where your products are tax-deductible? Are you following these regulations when collecting and remitting? Are you compliant? Since if you're not, the buyer will need to correct it before they buy itor reduce the price of the purchase."
2. If You've done it right, You Shouldn't Owe Anything More
"If you're doing it correctly, technically, it's net-zero to you." Rachel explained.
The sales tax is a consumptive tax, a tax to the consumer and not your company. It shouldn't be something you're having to pay out of pocket. It's up to you to collect sales tax on your customer's behalf -- and remit it to the proper government agency. The buyer is responsible, 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 sales tax two years later than it's due. So then it's all from your pocket."
3. Consumption Taxes Calculated Based on the Location that the buyer is located, not the location of the seller.
Taxes on sales are a bit complicated (especially those in those in the U.S.), but generally, what you need to remember is that sales tax is paid where the item is consumed (aka the location where your client is located). It is not determined based on the location of your business or the place of your corporate headquarters.
The most important data to source sales is the invoice number and the IP address of the computer. As the name implies, SaaS is taxed similarly to products, but not services which means that only 20 out of the 45 U.S. states with sales tax systems have tax rates that tax SaaS. Since the year 2018, if you've got enough taxable sales in a zone that exceeds the limit, then you're deemed to have economic nexus (a special shout-out for South Dakota v. Wayfair for this concept! ).
A threshold for sales is the quantity of sales that you have in a specific jurisdiction before you have to file taxes. Each tax zone (whether it's a territory, state, territory, or country at a global level) is unique in setting the threshold.
4. Tax Laws and Rules have Significantly changed in the last 10 Ten
Taxes on sales, VAT and various other taxation related to transactions have been reformed over the last ten years. Certain changes are more significant than others, and they have altered the landscape entirely.
2015: EU requires VAT collection From Non-EU Software Companies
1 January 2015 The EU has begun requiring software providers to collect and remit VAT based on the location of the purchaser and not on the location of the seller's company or employees.
The VAT rates are determined by the nation, which means countries are responsible to keep up with any adjustments to these rates on an individual level.
2018: U.S. Affirms That States May Collect Sales Taxes From Non-Resident Businesses
In the year 2018 it was the year that the U.S. Supreme Court ruled that states may charge sales tax for purchases by sellers outside of the state (including sellers who sell online) and even when the seller doesn't have an actual presence in the taxing state ( South Dakota v. Wayfair, Inc.). (A.k.a. the reason we are writing this post is because now, nonresidents as well as small-sized businesses must know about sales tax and its application.)
In the U.S., sales tax rules vary state by state. Florida and California are not required to collect of sales tax for SaaS subscriptions. However, New York and Pennsylvania do.
Then, in the year 2020 Massachusetts has reclassified SaaS charges in 2020 as "personal tangible property" that means SaaS subscriptions are now subject to sales taxes in the state.
In our conversations, Rachel offers other examples of tax law evolving for SaaS businesses around the globe:
"We are seeing, all around the globe, countries creating rules that specifically target non-resident businesses providing digital goods as well as services. Some will have a threshold of sales, some of them say every dollar is taxable."
5. Global Consumption Taxes Keep Getting More Complicated
The new tax laws are being passed that directly impact SaaS. Very soon, in different countries, SaaS companies running digital platforms could have to declare every seller that uses their platform.
What is the reason tax laws are becoming more complex?
Countries know they're losing tax revenue on digital sales that software companies don't disclose.
As a result, they're attempting to find new ways to monitor the movement of cash within their state or across the country, and also enforce their collections.
The 4 Ways SaaS Companies Can Manage Sales VAT and Taxes
How do SaaS firms determine the tax they have to be withheld and pay across the globe?
There are four approaches that we observe SaaS businesses employ to meet the tax obligation related to transactional taxes:
1. Don't Pay Attention
In this post, not paying sales tax is a common approach -- yet it could leave your company with many years of tax back as well as penalties, charges, and fees. The period in which this method could be effective is waning. While online shopping continues to increase, so too will the desire and capability to manage it.
2. Self-Help
Doing taxes on your own can be a great option for larger companies with the capacity to do the tax burden with an internal team.
It's just not as straightforward as integrating an automated tax tool into your sales software.
SaaS businesses also have to be thinking about:
- 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 when you'll have to pay taxes as well as file tax return.
- Remitting the correct amounts and filing returns on time for all tax jurisdictions where you are required to. This could be for a month, quarterly, or annually.
- Staying informed about changing tax laws and regulations.
- Responding to notices and inquiries from the tax authorities. Do they appear to be phishing or can it be taken action?
This can be burdensome for a finance department without technical expertise and cause resentment and turnover.
3. Employ an accounting firm
When you outsource your taxes it means that there's lesser internal resources to be utilized and it's likely to be more expensive. And rather than a customized method, employing an accounting firm usually means that they'll follow a more conservative strategy and ensure compliance to the maximum extent even though you would prefer to have a more personalized approach.
The perspective is one that only an inside tax professional could provide -- one that requires understanding the business strategy, the tax legislation, and how they intersect.
4. Use a Merchant of Record (MoR) and Outsource the Liability
At , we act as the official merchant for all transactions on your site and are responsible for collecting and remitting taxes on behalf of you. It doesn't matter if you're trying to deal with the tax rate reduction, custom taxation, tax-exempt transactions, B2C or B2B , everything is handled by us.
Merchants of record are there to assist you if any tax audits or inquiries arise. If an audit happens, we intervene and take the lead to ensure that you concentrate on building and expanding your SaaS company.
What's the best solution for your company?
Perhaps this seems overwhelming, but the worst option is to do nothing.
In the words of Rachel put it, "I can never promise that you'll never be audited. What I can say is that taking small actions now can make you a better candidate for far brighter prospects in the future."
In order to determine what is the best option for your company, she recommends assessing the resources available and the choices.
"It's really knowing the business and your location, as well as global tax regulations (duh) and the risks you are willing to take on."
Stream My Full Interviews With Rachel Harding
Part One: Why SaaS Companies Can't Afford to not pay sales tax
Part 2: How Stricter Tax Laws will Mean for SaaS
