Sales and use tax generally applies to the sale or use of tangible personal property and certain services. Since software, and especially Software-as-a-Service, may not be delivered in a tangible form, many technology and software companies have considered themselves exempt from sales and use tax. But this is not always the case. In fact, many states impose sales and use tax on services provided by the technology industry.
Of course, like many rules associated with sales and use tax, states are not unified on how they tax SaaS. You must look at taxability laws on a state-by-state (and often localities as well) basis to understand the taxability of your solution as a SaaS business. Check out our SaaS map here!
As if that wasn’t difficult enough, the taxability of the solution itself is not all you have to look at. Making sure you pay attention to a few key considerations will determine how you manage your SaaS solutions full sales and use tax obligations.
SaaS is currently the predominant delivery method for tech/software companies, followed by electronically downloaded software. Very few companies continue to deliver software via a tangible CD, thus believing their solution isn’t taxable because it is not tangible. Each delivery method can have a different sales tax treatment and differs by state. As software companies continue to change their delivery mechanisms, the states must adapt to their statutes. Software delivered by CD is usually taxable, while electronically downloaded software has a bit fewer states that tax it and SaaS has the least, but the number of states taxing SaaS is growing considerably (it amounts to roughly half the states currently).
Customization & Implementation
Often when software is sold, regardless of how it is delivered, ancillary products and services are sold with it: hardware, customization, implementation, maintenance contracts and so on. These products and services have their own unique tax treatment. Hardware, for example, falls into tangible personal property and is generally taxable.
Generally, services such as customization and implementation when separately stated on an invoice will be exempt from sales tax, but as is usually the case, it often depends.
Software maintenance can be mandatory purchases or optional, the taxability of this purchase often depends on this decision. Generally, mandatory support and maintenance will follow the tax treatment of the original software while optional support and maintenance can have a different tax treatment.
The situs is the location in which a taxing event occurs. It’s easy to determine when the entire transaction occurs at the point-of-sale but is more difficult when the transaction involves numerous sites.
Tax situs can affect both nexus determination and the taxability determination for SaaS businesses.
A company may, for instance, have a customer based in a state that levies sales tax on SaaS but many other users who access the software from all over the country. Consider where the benefit of use is received. In this example, the benefit of use is received where the users are located. That’s the situs.
This scenario makes for not only a complicated taxing situation but for an unclear invoice to the customer. Many businesses choose to apply tax based on the bill-to address of the customer.
In this situation, if the bill-to address is in a state that taxes SaaS, and the customer is aware that many of their users are accessing the software from states that don’t tax SaaS, the customer may ask you to break out the invoice accordingly. Other states, including Washington, have a “multiple points of use” exemption certificate that will relieve the seller from charging the sales tax and shift the responsibility to the buyer for accruing and remitting use tax. In this specific situation with Washington, the seller would still be responsibility for reporting retail business and occupations tax.
Got all that? Understanding sales and use tax when it comes to SaaS is a complex process unless you’re an expert in sales tax and are continually following updates on a state and local level. If you’re having trouble keeping track of all the changes and how they apply to your specific business situation, we can help. TaxConnex provides services to become your outsourced sales tax department. Get in touch to learn more.
Learn more about the taxability of SaaS in our state by state map!