How SaaS businesses can successfully navigate international tax compliance regulations during the hyper-growth phase
The nature of software as a service (SaaS) means software businesses of all sizes can launch subscriptions or digital services to a global audience from day one, quickly leading to hyper-growth if done successfully.
But for many SaaS vendors, particularly those in the startup phase, rapidly scaling internationally can soon lead to them falling foul of complicated tax compliance regulations. These issues often emerge late in the day, just as deals are being finalised, and can prove hugely costly at IPO stages when everything needs to be in tip-top shape. Therefore, SaaS businesses need to clearly understand and fulfil their tax obligations in every country or state they’re selling in, from the very outset, if they wish to stay on the right side of global compliance rules. The question is how?
While in some countries there are sales thresholds before taxes are due, in many there is no threshold and VAT, GST, or sales tax could be due from the first sale.
A taxing challenge for every SaaS vendor
All software companies face a unique set of tax compliance challenges that most startups and small firms simply aren’t prepared for. In many cases, tax and compliance teams consist of just one or two people, yet selling internationally quickly brings dozens or hundreds of different tax compliance regulations into play. Such volumes can soon overwhelm small teams, but failure to keep on top of everything leads to big problems if/when auditors decide to look at the books.
There are three main problem areas for SaaS vendors that need particular attention:
Understanding the full scope of national & international tax obligations
In the past, when an entrepreneur opened a brick-and-mortar business, tax compliance was relatively uncomplicated. They simply collected taxes on items sold — which typically were tangible physical goods — and remitted those taxes to the relevant local government. Simple. But for SaaS vendors selling virtual goods to customers potentially all over the world, things get a little more complicated. Even figuring out where they have tax obligations is a challenge in and of itself.
There are 195 countries in the world, nearly all of which have some form of sales or value-added tax (VAT). In simple terms, the more countries you sell to, the more regulations you must adhere to. Even if a company sticks to only selling in the US, there are 45 states that collect state-wide sales taxes, each of which has its own criteria for when businesses need to register and start collecting taxes, its own sales tax rates, and its own procedures and deadlines for doing so.
If you’re a SaaS startup looking to achieve hyper growth, it’s easy to see how quickly you can end up in hot water from a tax perspective without an army of tax experts on your side.
Understanding the specifics of software tax in every sales location
Different countries and states also have wildly different rules on how software is specifically taxed, often depending on how it’s being delivered to customers.
For SaaS vendors, that means determining whether they are leasing a service, providing a subscription, or selling tangible property, each of which has different tax obligations attached.
Once vendors start bundling products and services together (which is very common), things become even more complex. Most SaaS vendors sell suites of cloud-based solutions but also offer on-prem backup solutions that customers can load onto their local servers to keep processing transactions in case of network failure. These two solutions could also be subject to different tax rules, meaning they may need to be recorded differently on invoices as one sale of a bundle of products or sold as separately listed products.
Understanding the sourcing issues associated with SaaS tax
The final major tax compliance issue SaaS providers face is sourcing, which focuses on determining which jurisdiction’s tax to apply to a transaction.
When selling a digital product, there are many questions to sort through and answer before full tax liability can be ascertained. These include whether to charge taxes based on the buyer’s billing address or where the product is used, and how to apply tax when the product is used at multiple locations. This is now more common than ever following the rise of remote working.
For SaaS startups, answering these sourcing questions starts with a sophisticated CRM, billing system or ERP solution that can collect and store the kind of detailed information their tax team needed to answer these questions. Unfortunately, without a large tax team to advocate for that functionality, SaaS startups often fail to consider the need for it, until it’s too late.
Fortunately, help is at hand. There are a growing number of international tax compliance specialists, like Avalara, who work closely with leading ERP platform [SW1] providers to help SaaS vendors of all sizes achieve compliance in every country they sell to. Not only do they automate tax compliance functions by using an integrated solution that works seamlessly with other parts of your business’s platform, but also take the pressure off internal teams by ensuring that all tax obligations worldwide are being met.
Tax compliance can be a serious headache for any expanding SaaS company because each jurisdiction has its own sales tax laws, with vendors quickly falling foul of hundreds of local, national and/or international tax regulations if they aren’t careful.
But adhering to these laws isn’t optional — it’s essential for the success of SaaS businesses to accelerate growth and maximise efficiency.
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