Sales Tax on SAAS. What I Learned, and You Should Know!

I was presenting at the OpenView CFO Forum in Boston (on SAAS contracts) last week to their portfolio companies, and at the conference I learned quite a lot from the Grant Thornton tax presenters about the current state of confusion of the applicability of sales tax to SAAS transactions. GT wrote a short article on it, so I thought it was worth sharing on my blog, as their article was on point and timely (plus I thought I would provide my 2 cents worth).

My takeaways from the article are:

1) Current State: Most states have not specifically addressed taxation of software-as-a-service transactions, and so you have to shoehorn it into their existing rules (i.e. it is messy and a grey area).  You understand, as your hosting company is in x state, you are in y state and your customer is in z state.

2) Form of Agreement Matters: The form of agreement you use matters (is it a ‘software license agreement,’ ‘subscription services agreement,’  ’professional services agreement,’ or something in between), but of course so does the substance of the services you are providing.

3) Proposed Federal Legislation: There is no answer yet, but there is a bill going through Congress which could help provide some clarity and predictability on taxation of SAAS. Here is the latest on the bill (at least on one website).

Take a read of the short Grant Thornton article, as I think they nailed the current state of things–even if there is no clear guidance right now–and is a must read for your finance leader.

Disclaimer: This is provided for educational and informational purposes only, and is not legal advice. Hire an attorney for legal advice, as they should consider the pertinent facts and applicable law before providing any advice.

3 PRACTICAL Things to Remember About Collecting Sales Tax on Software

Ok this is a complex issue, but let me see if I can put together a few practical things to remember (at least from the perspective of a software attorney).

1) This is a State Law Issue. You really have to look at the rules on a state-by-state basis.

• Some states don't tax software and others do (example, NY);
• Some states only tax off-the-shelf software but not custom software (example, NC); and
• Some states tax the software if you send a CD/media but not if it is downloaded from the Internet (example, CA).

Takeaway: Figure out where your customers are, and then look at that state's sales and use tax law. I wish there was a website with a chart of which states require you to collect sales tax for software license sales, but I have not found it yet… if it even exists.

2) Don't Kick the Can Down the Road. I have seen too many software companies say I will deal with this down the road, but then find out it is really difficult and expensive to fix later. Think about it this way, you are supposed to collect and remit the sales tax to the state taxing authority, but if you don't you are still liable for the sales tax. It is really difficult and kinda of embarrassing, to call up your customer after the fact and ask them to reimburse you for sales tax on a transaction from years ago that you forgot to collect. If you don't get the sales tax money from them, you will still likely owe that tax.  By the way,this will come up during any investment or sale of your company. So the real risk is (a) you can't collect all the money you owe the taxing authority, and (b) you still owe that amount plus interest and penalties (not a great position to be in).

3) Get Reseller (Exemption) Certificates. You don't have to collect and remit any sales tax from companies that are reselling your software, however, get a resale certificate from them. The taxing authorities probably will ask for these certificates, and if you don't have them then you may be paying some tax you shouldn't owe. What needs to be in a resale certificate?  Here is one example.

So, while this is very complex and needs to analyzed on a state by state, and distribution basis, these are 3 practical things to remember.

Here is a lot more detailed information. Sales and Use Taxation of Internet Sales: Evolving Case Law.

Disclaimer: This is for informational and educational purposes, and no legal advice is provided. Consult your attorney for legal advice.