Do you sell software-as-a-service (SaaS)? Then you already have one of the most complicated situations in sales tax.
Your tax obligation and liability begin with where you have nexus, the connection between your company and a taxing authority or jurisdiction. Sales tax nexus was once defined only as a substantial physical presence, but for nearly six years – ever since the Supreme Court’s Wayfair ruling in 2018 – sales tax nexus can also be defined as an economic presence by just selling enough into a state. Physical presence has also long been able to create nexus.
Still, many providers assume that sales tax doesn’t apply to SaaS, which is often delivered via a cloud-based subscription application and may not seem to involve sales of tangible personal property (TPP). Wrong: Your SaaS product may be taxable and so might be your configuration and training expenses.
‘Software’ means a lot
How is software sold? Are maintenance or support services involved? These questions factor into determining whether sales tax applies.
SaaS is currently the predominant delivery method for tech/software companies, followed by electronically downloaded software. Software delivered via CD still has the most states that tax it, while electronically downloaded software has fewer. SaaS incurs sales tax in roughly half the states.
Many nuances affect sales tax and SaaS in various states. This includes whether you’re selling to a business or a consumer (as in Iowa, Maryland and Ohio), unique state sales tax rates (Connecticut), home-rule jurisdictions (Colorado and Illinois), partial exemptions (Texas), to name a few.
Though more common in telecom, infrastructure in a state can also create nexus for a SaaS company. States that have imposed sales tax obligations on the use of switches, towers and similar equipment have taken the position that a company can’t deliver their product without using such equipment in the state. This is sometimes called “attributional nexus” for a company and is a widely accepted position that’s been upheld in court.
Support, training and situs
Sales of SaaS often involve more than the cloud-based software and can include, among other services, configuration and set-up, training and support. Are these taxable?
Though some services are ordinarily not subject to sales tax, that they’re provided in conjunction with SaaS can make them taxable. Depending on the state, configuration, support or training may be taxable when provided in conjunction with SaaS, even if these services are separately stated on the invoice. In other words, one state may tax software delivered physically and tax SaaS, but not tax software downloaded electronically. Another state may tax SaaS but not downloaded or physically delivered software.
Ancillary products and services – hardware, customization, implementation, maintenance contracts and so on – have their own unique tax treatment. Hardware’s often easy, falling into the category of TPP; all states with a statewide sales tax treat the sale of hardware as a taxable event.
A maintenance agreement, though, might be treated differently for sales and use tax purposes depending on whether it’s mandatory or optional. In California, for instance, a separate charge for an optional software maintenance agreement is 50% taxable if you provide the purchaser with any physical products during the term of the agreement; otherwise, charges for the agreement aren’t taxable.
Factors potentially affecting the taxability of software and training include the type of software and delivery method (cloud and subscription, usually, in the case of SaaS); and whether the training is bundled or stand-alone, as well as how it’s delivered (in-person or virtually, for instance). Note that a growing number of states are also beginning to levy sales tax on services generally.
Tax situs can affect both nexus determination and taxability determination for SaaS businesses. Let’s say a company has a customer in New York (which taxes SaaS) but the customer has individual users accessing the software from all over the country. From a sales tax perspective, you have to consider where the benefit of use is received (in this example, that’s where the users are located).
But given modern technology and prevalence of remote use, SaaS situs creates questions. How can you really know these days from where a customer’s users are accessing the software? And do you have nexus in all those states and locations (remember: local sales taxes matter, too).
Obviously, SaaS has revolutionized the sales and use of software. Just as obviously, it’s created no end of sales tax issues for those in the industry.
If you sell SaaS in multiple states, not realizing your sales tax obligation could have big repercussions for your business. Contact us to learn more about how TaxConnex can take sales tax off your plate entirely.