Do SaaS Companies Afford to Ignore Sales Taxes and VAT? -
One thing I've learned while working at is how common it is to SaaS and software companies to ignore transaction-related taxes (sales taxes, VAT, GST, etc. ).
And I get it.
VAT, sales taxes, and GST are complicated, confusing, and not what leaders of software want to devote their time.
Also, know that ignoring transaction-related taxes could result in the need to pay the tax back sometime in the near future.
In one of my discussions with the Global Tax Director of's Rachel Harding, one of the most knowledgeable people I know about this topic She told me:
- 40% penalties and interest She's witnessed software companies incur 40% in 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 much more.
So to answer our own question: No it is not a good idea to ignore taxes on sales, VAT and GST tax.
In this piece, we cover five aspects SaaS firms need to be aware of regarding taxes. A lot of this information comes from my discussions with Rachel. Below, you'll be able to stream two of our conversations to learn more.
Five Things SaaS Companies Need to Understand about Sales Taxes
1. Sales, VAT taxes on GST and Sales Taxes may affect SaaS's Value
While Rachel worked on a group of tax specialists for mergers and acquisitions for small software companies she witnessed million-dollar price adjustments as a result of tax noncompliance.
"If you're looking to have any type of ownership change, whether it's a majority or minority investment, investors are going to investigate the company's operations," Rachel explained. "They will look at all your processes such as do you know of where your goods are tax-deductible? Are you adhering to these rules in collecting, remitting and paying taxes? 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've Done It Correctly There's no reason to owe anything More
"If you do it right technically, the net zero is not a problem 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 to collect sales tax on your customer's behalf -- and remit it to the right department of government. This is a buyer's responsibility, but a seller's obligation.
"It's when you're doing the wrong thing that it's an expense and liability in your balance sheet. Feasibly, you're not going to assess sales tax for two years following the time the tax was due. So then it's all out of pocket."
3. Consumption Taxes Calculated based on the Place of the Buyer, Not the location of the seller.
Sales tax is a complicated issue (especially those in those in the U.S.), but in general, the thing to remember is that sales tax is collected where the benefit of the product is realized (aka the location where your client is). It is not dependent on where you are, or the location of your company's headquarters.
In practice, the most important data to source sales is billing information and computer IP address. Like the title suggests, SaaS is taxed the same way as services and not goods, meaning only 20 of 45 U.S. states that have sales tax regimes have tax rates that tax SaaS. And since the year 2018, if you've got the amount of taxable sales in your area that is greater than the limit, then you're considered to be in economic nexus (a huge shout-out to South Dakota v. Wayfair for this concept! ).
A sales threshold is the quantity of sales that within a certain region before you are required to file taxes. Each tax region (whether it's at a national, state, territory, or even a national level) is unique in defining an appropriate threshold.
4. Tax Laws and Regulations Have dramatically changed over the past 10 Years
Sales taxes, VAT as well as other taxes related to transactions have been reformed during the past 10 years. Certain adjustments are more crucial than others, but they've changed the tax landscape completely.
2015. EU requires VAT collection From Non-EU Software Companies
1 January 2015, the EU started requiring software vendors to collect and remit VAT in accordance with the place of the purchaser rather than the address of the seller's company or employees.
The VAT rates are determined by the nation, which means governments are accountable to keep up with any changes to these rates on an individual level.
2018: U.S. Votes That States Can Collect sales tax from businesses that are not residents of the United States.
In the year 2018, 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) regardless of whether 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 piece is that non-residents and businesses of all sizes must understand sales tax and its application.)
In the U.S., sales tax regulations differ from state to state. Florida and California don't require the collection of sales taxes on SaaS subscriptions. However, New York and Pennsylvania do.
Then, in 2020, Massachusetts changed the classification of SaaS charges to "personal tangible property" which means SaaS subscriptions are now subject to sales taxes within the state.
In our interviews, Rachel offers other examples of how tax laws are evolving for SaaS companies around the world:
"We see, everywhere around the globe, countries creating rules that specifically target foreign-owned businesses that offer digital products and services. There are some that have a limit of sales. Some of them say every dollar is taxable."
5. Global Consumption Taxes Keep Getting More Complex
New tax mandates are being passed that directly impact SaaS. Soon, in many all over the world, SaaS companies running digital platforms might be required to disclose the sellers on their platform.
Why are tax laws getting more complex?
The world is aware that they're losing taxes on sales made online that software companies aren't disclosing.
As a result, they're finding new ways to trace the flow of cash in their states or nation and to enforce the collection.
The 4 Methods SaaS Companies Can Manage Sales VAT and taxes
So how do SaaS companies figure out all the tax they have to withhold and remit around the world?
There are four approaches that we have observed SaaS businesses employ to meet their obligations for transaction-related taxes:
1. Do not ignore It
In this article, ignoring sales taxes is a very frequent practice, but one that could make your company liable for many years of tax back, fees, and penalties. The time frame in which this strategy can work is shrinking. The pace at which online transactions continue to grow, so does the drive and ability to control it.
2. Self-Help
Doing taxes on your own is a good option in larger businesses that have the capacity to do efficiently with an internal team.
But it's not as easy as integrating the tax software of your choice into your sales platform.
SaaS companies also need to think about:
- Making sure 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 when you'll have to pay taxes and submit tax return.
- Remitting the correct amounts and filing returns on time to all tax-related jurisdictions in which there is an obligation. This could be for a month either quarterly, monthly, or annual.
- Staying informed about changing tax laws and regulations.
- Responding to inquiries and notices from the tax authorities. Are they phishing, or can it be taken action?
It can be a burden to a department that does not have knowledge of technology and may cause discontent and increased turnover.
3. Hire an Accounting Firm
When you decide to outsource your tax obligations it means that there's fewer internal resources needed however it will increase the cost. In contrast to a custom method, employing an accounting company usually implies that they'll follow a more conservative strategy and ensure compliance to the maximum extent even though you would prefer an approach that is more tailored.
It's an insight that only an inside tax professional could provide -- one which requires a thorough understanding of the company, its strategies, tax regulations, and the ways in which they are all interconnected.
4. Make use of an Merchant of Record (MoR) and Outsource the Liability
We are the merchant of record for the transactions you make on your site, making us responsible to collect and pay taxes for you. If you're looking to handle reduced tax rates, customized taxation, tax-exempt transactions, B2C or B2B , everything is handled by us.
The merchant of record is in your corner should any tax audits or inquires come up. In the event of an audit then we step in and assume the responsibility -- so you can stay focused on building and growing your SaaS business.
What's the most effective solution to your business?
Maybe this is all confusing, but the most damaging thing you can do is nothing.
As Rachel put it, "I can never promise that you will or won't receive an audit. What can I can promise is that small steps now could set you up for a far brighter prospects in the future."
For determining what's the most effective for your business it is recommended to evaluate your resources and your alternatives.
"It's essential to know your company's needs and your location, as well as global tax law (duh) and the risks you're willing accept."
Stream My Full Interviews With Rachel Harding
Part One: Why SaaS Companies Can't Afford to Ignore Sales Taxes
Part Two: What Are the Stricter Tax Laws Mean for SaaS
