There are over 15,000 SaaS companies established worldwide, yet many of them may not even know how to manage, file, and coordinate their taxes. Dismissing the importance of sales taxes can lead to companies of all sizes paying the price… sometimes up to millions of dollars in back taxes, non-compliance fees, etc.
The fast paced nature of SaaS companies can often lead to sales tax oversight. Sales tax compliance is paramount for them to run their business successfully. Sales taxes form the background of many problems SaaS companies face that could potentially hit them out of nowhere.
It’s been a long time since anyone has opened up classic software from a box and installed it on a floppy disk.
We’re now in an age where software-as-a-service has become the most accessible and universally accepted software model in the industry. This has affected tax laws and regulations across states over the last several years.
This makes it even more essential that anyone -- whether you’re a SaaS entrepreneur, a financial consultant, a CFO, or even an accountant -- learns how these taxes are processed.
In today’s blog post, we’re going to explore the different tax terms, regulations, and practices SaaS companies need to know. Then, we’ll investigate how anyone can position their SaaS for success by handling these taxes properly.
Sales Taxes, Tax Regulations, and General Rules for SaaS Companies (from B2B to B2C and Beyond)
First, SaaS companies need to define where they stand with “nexus.” There are physical and economic nexus activities, and this varies by state. SaaS companies need to know where they fall under nexus because they could be filing their taxes incorrectly based on this information.
For clarification, “nexus” is just a term that is used to describe a company’s sufficient connection to a specific taxing authority. Ultimately, nexus will determine whether a company has a collection and filing obligation to a taxing jurisdiction depending on the goods or services that it sells.
Depending on the state, this definition can fluctuate, since every state processes taxes differently.
Physical nexus refers to companies that have a “physical presence” within their state. In some states, economic nexus refers to companies that surpass a certain dollar threshold (the amount of money they make that year), or make a very specific number of sales transactions within the state where they’re based.
There’s also a sales tax nexus and income tax nexus, and both are important to know for SaaS companies.
How Does This Impact SaaS Companies?
The United States categorizes software taxes into a few categories: downloadable, tangible, custom software purchased on a disk or CD, customizable software configured by the user, and cloud-access software. SaaS companies run on a cloud-based server to give users instant accessibility, which would put them in the latter category.
Despite this federal rule, it still depends on how the state imposes sales taxes to note how they impact your SaaS.
(Side note: if you operate your SaaS company in a state that does not impose sales taxes, you may not have to worry about sales taxes at all. As of 2021, these states include Alaska, Oregon, Montana, New Hampshire, and Delaware).
Here are some common points to consider as a SaaS company::
Where is my company headquartered , and how does it impose sales tax?
Does my company’s sales revenue to customers in other states lead to economic nexus?
Do current business activities in other states lead to physical nexus?
Is my SaaS taxable?
Is my SaaS NOT taxable?
Is my SaaS taxable only for specific uses? (ex: personal use or business use, only)
How often do I need to file?
What evidence do I need to provide in case I’m audited?
What are the penalties for non-compliance?
As a reminder, SaaS sales taxes could apply to where your company is based -- which includes the office and/or warehouse your team is located, where your employees work, etc. -- and how you sell to customers within and across state lines.
The point is, depending on your state, you’ll need to track sales and revenue so that you pay the appropriate amount to not only your state but where your customers are based.
This is where the word “nexus” comes back for a bit.
Because, depending on whether or not your SaaS company qualifies for nexus, you’ll have to pay tax revenue to those states where your customers are based. Missing out on this can lead to thousands if not millions of dollars in backend taxes, and no one has time for that.
Breakdown: A General Taxability Overview for SaaS
Software as a Service Sales Tax Overview:
The taxability of a cloud-based software, often referred to as software as a service (“SaaS”), can greatly vary among the states. Furthermore, states have come up with a variety of interpretations for this offering, which often adds confusion to the already challenging tax environment.
For example, some states consider “canned” or “prewritten” software as the sale of tangible personal property (“TPP”). In that case, the software is subject to tax. Likewise, these states may also treat SaaS in a similar manner. The customer is accessing the software in the same manner as if the software was downloaded to a computer.
A state’s law usually lags changes in technology. There are still a handful of states that do not consider software that is delivered electronically to the customer to be a sale of tangible personal property. Likewise, these states do not tax a SaaS product because nothing physical is required to access the software.
Another interpretation that a couple of states have produced is that SaaS can be viewed as the rental of tangible personal property, since the customer doesn’t own the software but is accessing the software on a subscription basis. In that case, the software is subject to tax.
One other interpretation (unique to only a couple of states) is that SaaS is the provision of a computer and data processing service.
Texas Sales Tax for Software as a Service:
Texas is one of these states that considers SaaS as a taxable data processing service.
Data processing is 20% exempt from sales tax. In that case, Texas provides a 20% exemption on the total charge to the customer for a data processing service.
Another way to put it is that 80% of the total charge to the customer represents the actual taxable amount. Rather than utilize the standard maximum sales tax rate at 8.25%, it’s common for SaaS companies to instead utilize a 6.6% rate to calculate the tax amount.
B2B vs. B2C SaaS: What’s the Difference?
Yes, there’s a big difference between B2B and B2C SaaS taxes.
Why? Because they target completely different customer bases. B2B SaaS companies market and sell their software to registered businesses, while B2C SaaS companies mostly sell their services to individuals. Of course, there are cases of mix-and-match customers, but this is more uncommon than not.
This also depends on the state and how you identify your business model. Both types of SaaS companies need to pay attention to the right tax jurisdictions in their respective states, so that they’re filing and remitting taxes correctly both within and across state lines.
What About International Sales? (VAT, VAT MOSS, etc.)
This is tricky territory, but if you’re a United States-based SaaS selling to customers based out of the country, you need to keep in mind that the jurisdictions are not going to be the same.
When selling internationally, the same idea still applies. Keep track of your customers, and pay attention to the regulations and jurisdictions of where they live. Depending on how they operate, you’ll have to pay taxes accordingly so you don’t end up in hot water.
For example, we’ll discuss how sales taxes are regulated in the European Union. To understand this entirely, there’s a term you should know: VAT.
VAT stands for Value-Added Tax.
According to the European Union Commission's official website, VAT is a “broadly based consumption tax assessed to value added to goods and services.” They break this down further by adding that all potential used goods and services that “are bought and sold for use or consumption” in the European Union count towards VAT.
So, how is VAT relevant to SaaS companies and international selling?
The UK government website states that if a service qualifies as a digital service, that service is taxable. You won’t be able to avoid paying taxes when selling to customers in the UK.
How VAT MOSS Helps Streamline Tax Processing
No, you’re not going to be able to avoid paying taxes to European customers if you’re selling to them from the USA. But, you can make the process much easier if you register for a VAT MOSS (Mini One Stop Shop).
While this is entirely optional, VAT MOSS makes it possible to account for VAT in just one European country. This saves your team time, money, and a ton of management responsibility just by consolidating the VAT processing in one location.
If you’re selling to the Middle East, consider details regarding the Middle East VAT as well. While this is newer (introduced in 2018), it still covers all Gulf Cooperation Council countries.
How to Prepare Your SaaS Company for Taxes
When preparing taxes for your SaaS company, you need a good team. People that can handle accounting preparation, finances, income and sales tax information, revenue details, and more in the backend of your business.
State Tax Advisors provides in-depth consulting services and compliance services for SaaS companies of any background and practice. If you’re interested in learning how we can help you manage your sales tax for your SaaS company, give us a call.