Do SaaS Companies Ignore Sales Taxes and VAT in 2022? -
One of the things I've discovered while working is that it's common for SaaS and software companies to disregard transaction-related tax (sales taxes, VAT, GST, etc. ).
And I get it.
VAT, sales taxes, and GST are complex, confusing, and not what IT leaders would like to invest their time.
But also, you should be aware that not paying taxes related to transactions can lead to a risk that goes beyond the payment of some back taxes sometime in the near future.
I had a chat with global tax director Rachel Harding, the most knowledgeable person I know about this topic.
She shared with me:
- 40% penalty and interest She's witnessed software companies incur 40% in interest and penalties for not complying with taxes on sales in the state.
- Multi-million dollar valuation adjustments from historical sales tax noncompliance during acquisition due diligence.
Plus much and more.
In answer to the question we asked ourselves: No, you shouldn't ignore taxes until 2022.
In this article in this piece, we discuss three aspects SaaS firms must be aware of concerning taxes. The majority of the content is derived from my chat with Rachel who you can play the complete video of our conversation if you want to hear the full range of her thoughts.
Three things SaaS Companies Need to Understand Concerning Sales Taxes
1. Sales Taxes are calculated based on the Location of the Buyer, not the Seller
Sales taxes are complicated (especially those in those in the U.S.), but generally, what you need to know is that sales tax is paid where the item is being consumed (aka the place where your customer is). The tax isn't dependent on where you are or the place of your corporate headquarters.
The most relevant data used to determine the source of sales is the billing as well as the computer's IP address. The name suggests that SaaS is taxed the same way as services and not goods and therefore only 20 of 45 U.S. states that have sales tax laws are actually taxing SaaS. In 2018, if you have enough taxable sales in a region that exceeds the specified threshold, you will be deemed to have economic connection (a special shoutout for South Dakota v. Wayfair to explain this concept! ).
A sales threshold is the quantity of sales that within a certain area before having to pay taxes. Each tax region (whether it's on a state, territory, or country level) offers its own method of setting the threshold.
2. The Tax Laws and Regulations have dramatically changed over the past 10 Ten
Sales taxes, VAT, as well as other taxes related to transactions have changed a lot during the last 10 years. Some changes are more important than others and have changed the tax landscape completely.
Two historic changes include:
- 1 January 2015 The EU has begun requiring software providers to collect VAT and to remit it based on the location of the buyer rather than the place of operation for the business or its employees.
- In the year 2018, The U.S. Supreme Court ruled that states may charge sales tax on purchases made through sellers located outside the state (including online sellers) regardless of whether the seller doesn't have a physical 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 and small businesses need to know about sales tax and the way it is applied.)
If SaaS is tax-deductible is a subject that has been re-defined in several areas as well.
In the U.S., Florida and California do not require the tax collection on sales taxes for SaaS subscriptions. But New York and Pennsylvania do.
Massachusetts didn't require sales tax collection for SaaS. However, in 2020 the state reclassified SaaS fees to "personal tangible property" which means SaaS subscriptions will be in the tax bracket of sales taxes within the state.
And these changes aren't just occurring in the U.S.
In our interview, Rachel offers several examples of how taxes are changing for SaaS companies around the world.
There's no reason that each SaaS founder or CEO has to be an expert in taxation not at all.
It is important to remember that you need to know enough about tax preparation to be sure you are making it the right way and to find an IRS partner that with whom you are able to be confident in.
3. If You've Done It Correctly, You Shouldn't Owe Anything Additional
"If you're doing it correctly technically, then it's zero to you," Rachel explained.
Sales tax is a consumption tax -- a tax on the consumer, not your company. It shouldn't be something you're having to pay out of pocket. It's up to you to to collect taxes on the buyer's behalf, and remit it to the proper public agency. It's a buyer's liability and a seller's responsibility.
"It's the moment you're doing it wrong that it becomes an expense , and even a liability in your balance report. In the event that you don't, you're unlikely be able to charge a sales tax for two years after the tax was due. Then it's from your pocket."
The 4 Ways SaaS Companies Can Manage Sales Taxes and VAT
Then how can SaaS companies figure out all the taxes they need to pay and withhold across the globe?
Four approaches we see SaaS businesses employ to meet their tax obligations related to transactions:
1. Ignore It
In this article, ignoring sales tax is an extremely popular practice -- but one that can leave your company with years of back taxes or fees and penalties. The period in which this method will work are waning. As online commerce continues to grow, so is the motivation and capacity to control it.
2. Self-Help
Making your taxes yourself is a good option in larger businesses that have the resources to manage it effectively with an in-house team.
However, it's not as simple as plugging an automated tax tool into your sales software.
SaaS businesses also have to think about:
- Make sure that your data is clean and accessible.
- Knowing what is taxable as well as the charges to be charged.
- Monitor tax thresholds so you know the deadlines to pay taxes as well as file tax return.
- Making sure you pay the proper amount and filing returns on time in all tax authorities where you are required to. This could be either quarterly or monthly. annually.
- Keeping up to date about changing tax laws and regulations.
- Responding to notices and inquiries by the tax officials. Do they appear to be phishing or is it actionable?
This could be difficult for finance departments that do not have technical expertise and cause resentment and turnover.
3. Find an Accounting Firm to hire
If you contract out your tax preparation it means that there's fewer internal resources needed, but it's going to increase the cost. Instead of a custom method, using an accounting firm typically means that they'll follow a more conservative strategy that is compliant to the highest degree regardless of whether you'd like an approach that is more tailored.
The perspective is one that only an in-house tax expert can provide -- one that is based on understanding the business strategy, the tax regulations, and the ways in which they all intersect.
4. Use an Merchant of Record (MoR) and outsource the Liability
As a company, we are the primary merchant on every transaction on your website and are responsible for collecting and remitting taxes on behalf of you. It doesn't matter if you're looking for the tax rate reduction, custom taxes, tax-exempt transactions B2C and B2B- it all is handled for you.
Merchants of record are in your corner should there are tax audits or questions that are raised. When an audit occurs We intervene to take the lead and allow you to stay focused on building and expanding your SaaS company.
What's the best solution to your business?
Perhaps this seems overwhelming, but the worst thing you can do is to do nothing.
According to Rachel said, "I can never promise that you won't receive an audit. What can I can promise is that small actions taken now will make you a better candidate for much brighter future."
To figure out what's best for your business, she recommends assessing the available resources and options.
"It's all about knowing your business, your footprint, global tax law (duh) as well as the risk you're willing to take on."
