Defining Your Tech Solution for Tax, Regulatory Compliance

Technology’s bull rush to keep up with consumers’ demand can mean products and offerings cross lines in taxation and regulation. Is your solution is only software as a service (SaaS) or does it dip into information service or telecommunications? Does it have auto dial functions, SMS capabilities, and call routing?

The answers can change the nexus, taxability and even how you charge and bill and collect the taxes. The key to tax compliance is to unpack exactly what your solution does and how it does it.

Definitions

Generally defining your telecom service for taxability is a good first step. What, primarily, do you offer?

• SaaS that allows a customer to leverage computational capabilities of a hosted software application.
• Information service, a hosted app for a customer to retrieve information that’s sometimes not easily available (such as a subscription-based tax or law service), delivered in either a tangible or electronic fashion.
• Telecommunications services, broadly defined, offered for a fee directly to the public regardless of the facilities used. This includes the transmission of images, sounds or signals over radio, wire, optical or other electromagnetic systems.

Precisely defining services initiates breaking telecom services, which are often bundled these days, into components that may incur different tax and regulatory treatment. SaaS, for example, can cross into a telecommunications service when it provides call routing, auto dialing or SMS messaging; this could create communication-related taxes.

Everyday companies primarily known for SaaS or software solutions often also integrate voice and SMS/text messaging capabilities, with examples ranging from Slack and HubSpot to Microsoft Dynamics 365, Google Workspace and Shopify.

(For more examples, listen to our webinar “Deciphering Tax Obligations: Accurately Defining Your Technology Solution for Tax and Regulatory Compliance.”)

Tax classifications

State and local taxation, fixed by state and local statutes, depend on the nature of a transaction and the type of product/service sold such as telecom, SaaS or mixed services. Classification affects the application of sales taxes, communications taxes, 911 fees and more.

Jurisdictions may classify the same service or component of a telecom service differently, leading to varied obligations. For example, a service may be exempt from state sales tax as SaaS but subject to communications taxes and 911 fees due to its telecom components. You could be surprised by the scope of your tax responsibility, especially if you’re one of those tech companies that can’t fathom being called a communications company. Telecom taxes can also be different from sales tax rates in states such as Florida and Illinois.

Optimization

Optimization can reduce (or at least clarify) your tax and regulatory obligations by breaking out the components of your potentially bundled telecom services.

You have to be sure to accurately map your types of transactions and assign allocations, or percentages of your service offering that a component such as SaaS constitutes, by transaction type. You also need to scrupulously document your optimization process so it can stand up to a potential audit. One step in optimization is to ask simply, what’s being sold? How would the customer describe your product?

Understand all aspects of your bundle, and how it helps to understand how your customers perceive it. What are the individual components of the bundle? How is it marketed, contracted and invoiced? What is the true object of the bundle?

(That last can be a key taxation question for telecom, where offerings are generally added to repeatedly over time to meet evolving customer demands.)

Don’t forget about talking to your product managers to determine the potentially taxable details of your offerings.

Transaction mapping

Determine the categorization of your offering: Is it VoIP, wireless, SaaS and so on? Is it sold interstate (which opens federal regulatory possibilities) or only intrastate? Not all states treat VoIP as a regulated telecom, meaning you may have tax obligations but not regulatory ones. Keep reviewing to see if further segregation is required.

Depending on the jurisdiction, telecom-related taxes walk a strange path. For instance, sales taxes are trust fund taxes. What you collect, you collect for and remit to the states; you’re not charged tax on the sales tax you collect. With some communications taxes, however, you’re allowed to recover those taxes by charging your customers – but some of those fees/taxes become part of your revenue base for calculating sales and communications taxes.

Also consider that historically communications offerings trigger nexus, the connection between a tax jurisdiction and a company that creates sales tax obligations. The theory is that a company is using infrastructure elements to maintain a market: Telecom creates nexus in and of itself, equivalent to physical presence. So you may host a SaaS app outside a state and so have no physical presence. Add a communications service to that SaaS bundle and you may create a physical presence in the form of communications services.

Determining value for tax purposes

You need a method for calculating the value in the bundle of telecommunications services. Allocation can be created by dollar value breakout or percentage of use via such methods as ala carte or cost-plus determination of the dollar value, usage-based percentages (often using metrics such as minutes/bytes) or competitors’/market data to determine dollar value.

Make sure your recordkeeping is consistent with your bundling valuation methodology. Invoicing and contracts must be consistent with your bundling methodology, and your registration and licensing must support your regulatory position. Among other advantages, this will give any eventual auditor a lot more faith in your processes.

Seek the advice of experts when you are in doubt, or at the very least to review your methods and practices.

(For more, including how the components of bundled services directly impact taxes, fees and customer costs in states such as Florida, listen to our webinar “Deciphering Tax Obligations: Accurately Defining Your Technology Solution for Tax and Regulatory Compliance.”)

TaxConnex handles sales, use and telecom tax management, freeing your team to focus on what matters. Contact our experts to learn how we can help take sales tax obligations off your plate.