Authored by Gary Peric
State and local taxes have become much more complicated for technology firms. This includes companies that sell downloadable software or software as a service (SaaS) and do not physically enter the states where their customers are.
Historically, sellers of products or services that were taxable by state and/or local authorities had to collect and remit those taxes only if they had a physical presence in that state or locality. For companies selling downloadable software or SaaS, which often have physical presence in just one state, managing sales tax registration, collection and remittance was not as complicated as it is post-Wayfair.
On June 21, 2018, by a 5-4 decision, the Supreme Court overturned decades of precedent in the South Dakota v. Wayfair, Inc., et al ruling. The court upheld South Dakota’s SB 106, which requires remote retailers that conduct $100,000 in sales or 200 transactions in the state to collect and remit sales taxes to the state.
The ruling was hailed by brick-and-mortar retailers, which have long felt that the sales tax treatment afforded online sellers was an unfair advantage. For software companies, the ruling can mean significant sales tax compliance changes.
What states are doing
In the wake of the ruling, the majority of states have adopted or are planning to adopt economic nexus sales tax imposition rules that require out-of-state sellers to collect and remit sales taxes. Most, but not all, are following the South Dakota threshold of $100,000 in sales or 200 transactions.
See Baker Tilly’s multistate economic nexus chart for standards and effective dates. We anticipate all states that impose a sales tax will implement an economic nexus standard in the near future.
In-house or outsourced?
Companies large enough to meet the sales tax thresholds in multiple states now must decide how much (if any) of the increased compliance workload they want to keep in-house and what functions are better outsourced. The determining factor is how much a company wants to invest in developing and maintaining a sales tax compliance infrastructure.
Most newer and startup technology companies choose to outsource for the following reasons:
- They need to demonstrate to current and potential investors that they are in compliance with tax laws.
- They need to prove to potential buyers that there is no material sales tax exposure that will interfere with any deal.
- They have limited internal resources available to establish and maintain a sales tax compliance function.
Best practices in managing sales taxes
Companies that outsource the process to collect, remit and administer sales and use taxes should choose a provider that can assist with the following:
- Determining whether the software license or subscription fee is subject to taxes in the jurisdictions where the company has sales
- Identifying which state to attribute sales revenue to (when, for example, a customer has locations in multiple jurisdictions)
- Assisting companies in identifying, quantifying and satisfying any historic sales tax liabilities
- Registering the company, filing sales tax returns and responding to compliance-related notices
- Documenting appropriate policies and procedures
- Training company personnel to take over the process at some point
- Evaluating tax processing software for potential internal use
That provider should also evaluate which of the company’s ancillary services, such as installation, training, support and other revenue streams, are taxable. The provider should review how those services are described in customer contracts, invoices and on the company’s website as part of a comprehensive taxable study.
Ideally, the time to bring in a provider is prior to mass-marketing products or services, and definitely prior to any financing stages or other investment events.
Another best practice is to break out all charges to clients/customers since some may be taxable and some may not. If all are billed together, a state may assert that the entire invoice is taxable.
For more information on determining the taxability of SaaS, see Sales-and-use-tax considerations of software as a service, written by Baker Tilly state and local tax specialists for the AICPA The Tax Adviser.
What companies should do internally
Companies that choose to outsource are still responsible for remaining in compliance with state and local regulations and should designate an internal company champion to work directly with the provider. That person should also coordinate with the provider to determine which functions can be moved to in-house personnel over time.
Keep clients informed
If clients will be paying sales taxes on your products or services for the first time, communicate with them before issuing the first invoice that includes those taxes. In addition, include with the invoice an explanation of why sales taxes are being charged.
Companies should also review their customer contracts to ensure they explicitly indicate that the customer is liable for all sales/use tax attributable to the license or purchase.
Monitor new developments
Because these changes in sales tax laws are so recent, legislation, regulations and interpretations of the new regulations are sure to change. We highly recommend regularly monitoring jurisdictions where your company has sales now, or will have sales in the future, for changes.
For many technology companies, these new sales tax laws and the dynamic nature of state-by-state legislation requires expertise most firms won’t have in-house. Baker Tilly’s professionals monitor legislative and legal developments in every state and have experience helping technology firms of all types comply with new regulations. As companies make decisions about what operations to retain and which ones to outsource, as well as the most efficient ways to manage the ongoing processes, Baker Tilly can be a valuable resource.
For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.