When Tax Takes a Bite Out of Your SaaS
The demise of on-premise solutions started ten years ago, but it’s safe to say that Covid accelerated their death as businesses looked for solutions that could be everything, everywhere, all at once for their business. SaaS is expected to grow 214% through the decade starting in 2020, reaching 814B in 2030 [Grand View Research (2023). Software As A Service (SaaS) Market Size, Share & Trends Analysis Report].
As a SaaS business itself, Fonoa is aware of the challenges rapidly growing SaaS enterprises face. We work together with some of the biggest SaaS businesses in the world to ensure financial operations, especially in regards to tax, don't get in the way of growth. Here are a few considerations when expansion is being driven by global demand to make sure you stay ahead of the tax man.
The rapid expansion that SaaS businesses experience will burden tax and finance in keeping up with regulations in so many countries. Finding a partner for tax that understands this pain and can scale with you is critical.
The VAT impact: cross-border sales of software is not just an “export”
Before the digital economy, cross-border services were more exotic and often went untaxed as exports. The digital economy changed this. The fast growing volume of online cross-border transactions pressed governments to find ways to tax this new way of doing business. The taxation of electronic services started as early as 2006 when the European Union introduced taxation for electronically supplied services. Of course, the definition of electronically supplied services was not uniform across EU member states and was difficult to enforce; it didn’t stop countries around the globe from introducing their own rules.
No problem, we just won’t register for VAT.
You know, the old adage about death and taxes; it applies here. When countries introduced taxes on electronic services, it also meant they needed to make it fair for local companies so most introduced a responsibility for foreign companies to charge VAT. There are a few different ways this can apply:
- Immediately (meaning if you sell at all, you have to collect VAT)
- Only when selling to private consumers (B2C)
- Upon reaching a specific threshold of sales.
The application of this varies around the world and it's worth understanding the rules in countries where you have sales.
For countries where we have to charge VAT, what does that entail?
Registration is actually the simple part. Once you are registered, tax is calculated as part of the transaction and the invoice issued often needs to comply with the local rules and will be dependent on whether the transaction is B2B or B2C.
To further complicate things, some countries now require non-resident businesses to comply with digital reporting regulations. At a basic level, this means submitting the invoice information to the tax authorities and receiving electronic confirmation. This all has to be done in real (or near-real) time.
Of course, periodic filings will be required; either monthly or quarterly but usually on a simplified form as only output VAT will be reported. The simplified return is the only thing simple about this process when you are a digital business operating globally.
What happens if we decide not to register, can they catch us?
Well, we aren’t tax advisors and it depends on your risk appetite. We can tell you that many countries publish “naughty” lists for non-resident businesses that are not complying with local tax laws. It's not a great look from a public perception standpoint and could impact your ability to meet stringent requirements for issuing an IPO or your next round of financing.
Moreover, not meeting tax compliance requirements often means businesses need to provision for these latent liabilities in their financial statements. Auditors tend to be strict around this. Some countries go further in their enforcement attempts and block your (online) businesses’ IP address or find other ways to make it effectively hard to operate in the country.
Finally, it’s good to note that global tax authorities do not forget. If you pursue a lasting business in their country, you will sooner or later have to comply. If you’re late, it often means adding late interest and penalties to your payment obligations. If you’re willfully non-compliant, you may wish to tell your non-resident company director to reconsider any holidays they have booked in that country (or prepare to answer some tough questions on arrival).
Well at least US Sales Tax doesn’t apply to SaaS.
That would be nice, but that is no longer the case. Many states apply sales tax on SaaS sales. With its complex web of taxing jurisdictions requiring a precise address, the US makes it very difficult to assess tax and impossible to manage these rates manually accurately.
Last we checked, 21 states were taxing SaaS sales with a further 3 making it dependent on the end consumer. It's important to note that this is constantly changing, so having a reliable technology partner is essential.
Wait, is there also an income tax component?
Generally speaking, no, not yet. While many countries have introduced DSTs - Digital Services Taxes, these tend to be targeted to advertising, data collection, platform businesses - targeted at Google, Meta and TikTok or similar companies.
A DST is a simplified income tax that eliminates the need for robust income tax reporting that comes with being located in a country and just applies a tax on revenue. The calculation varies by country, and many have argued against its introduction (citing double taxation, and the possibility of improving other methods of taxation such as VAT and GST).
I'm feeling pretty overwhelmed here. What should I do?
The quicker your business grows, the faster your potential task risk grows. The first thing to consider is whether your current data collection during checkout is sufficient to determine your risk. Are you collecting business registrations and VAT IDs for all business customers, even in countries where you don’t have a physical presence?
If your business is largely B2C, your risk is even greater as you will be responsible for VAT/GST in most countries.
Reach out to us, we can help with technology and solving master data gaps; ask your tax advisors for a health check; just do something. Visit our page dedicated to technology that can support the indirect tax needs of software companies like yours.
