How to navigate your way through tax compliance in the US as a subscription business

Finance
How to navigate your way through tax compliance in the US as a subscription business
Article by Mark Carpenter (Senior Strategic Alliances Manager at Avalara) Heather Smith (Marketing Manager at Avalara), Oliver Viel (Head of Marketing at keylight) and Sally Farrant (Partner Manager at keylight).

 

Competitive subscription businesses are likely to be thinking globally right from the get-go, particularly those which align with the forward-thinking vision of the Subscription Economy. Currently the conditions for global expansion are better than ever because forward-thinking businesses can rely on automated digital systems to smooth workflows and enhance creativity across borders. Yet, there are still some significant complications which can arise when companies take the plunge to expand their subscription offering across multiple countries, particularly within the US. One such difficulty is that of local tax policies, each of which have their own rules and regulations which differ from state to state. These rules are complicated and are often subject to change, so it can be hard to keep up. How can those who desire to grow their subscription business cope with the complications of tax and billing? 

       It can be hard to deal with tax compliance in one country, let alone with individual tax regulations around the world. All global businesses must have the infrastructure in place to deal with taxes in every country or state they operate in. When it comes to the running of modern platform companies, tax becomes even more complex because it demands an automated process that easily integrates with digitised workflows. One component often overlooked is the substantial tax compliance risk faced by companies using recurring payment models. In many cases, recurring billing translates into a source of tax risk, particularly within the US. Success is all in the planning and businesses need to have the resources to be able to factor in the very different and complex world of sales tax, with its 12,000 different jurisdictions, differing product taxability and constantly changing rates. Businesses should not be put off from expansion in the US, but understand the steps which will lead to success by reviewing the following:

1. Understand obligations and rates for each transaction 

       Merchants with stock, people or property in a state have obvious obligations (sales tax nexus) and generally need to register and collect sales tax on transactions. When it comes to out-of-state or country transactions, then the business also needs to factor in economic nexus (typically 200 separate transactions or $100k in sales) which applies to remote sellers. With a subscription-based business, it can potentially be even more complex, as it’s not only where the company has nexus, but where the service is being used (e.g. a company using a SaaS service must declare where their employees are based so that rates can be calculated based on the various locations). Once nexus obligations and locations have been understood, then the rate is dependent right down to the geolocation, particularly within the USA. This is because there are multiple tax rates in each state, rates that can vary from street to street and even from house to house. The work required to track changing rules, rates, and boundaries is a resource drain most companies cannot afford.

2. Apply the right sales tax holiday to the right product or service

       Sales tax holidays are specific days when sales tax is not charged in certain circumstances, giving consumers an opportunity to purchase goods and services tax-free. For example, “Back to School” holidays in some states exempt clothing purchases from sales tax on specific days or below certain dollar amounts. By their very nature, these tax holidays are ad hoc and unpredictable. The holidays vary by type of goods exempted, time of year, and duration—and have no consistency from state to state.

3. Know sales tax-exempt transactions

       Not all customers are required to pay sales tax. Depending on the rules in the taxing jurisdiction, certain businesses and individuals may be exempt from paying sales tax (eg charities, resellers and government agencies). It is up to the vendor to collect and keep on file a valid exemption certificate for each business, organisation, or individual with an exemption.  

       With subscriptions, tax-exempt transactions occur based on the tax status of the customer or taxability of the product in question. Where a subscription is sold to a tax-exempt customer then the status must be checked with each transaction/invoice to ensure their status has remained. With a clear process or by using technology, the audit risk for tracking, filing and verifying the certificates can be dramatically reduced.

4. Understand product taxability for traditional and emerging technologies

       Many states are addressing budget gaps by increasing the number of products and services included in taxability rules. Historically, most sales of tangible personal property (TPP) have been subject to sales tax. This is shifting to include intangibles such as digital, professional services and implementation services. Many states routinely apply sales taxes to services, including specialised training, experience, or project-related staff hours.

       When it comes to the taxability of virtual products and services such as eBooks, digital music, or streamed movies, the taxability issues are extensive. How is a digital good defined? How does the relevant authority tax it? Are there certain cases when it is exempt? How does a one-time purchase differ from a subscription model when it comes to purchasing the item? States that are members of the Streamlined Sales Tax project (SST) use a somewhat-unified definition of digital goods to include movies, music, books, and other related goods. Whether these are considered taxable depends on the jurisdiction in question.

       For subscription-based business, product taxability is always a source of confusion. For ecommerce companies providing virtual goods or services, the bottom line is to hire an expert. Beyond that, the difficulty can be broken down into problems of definition or interpretation of vague rules by the states in question.

5. Prepare for success with the cloud

       Dealing with tax properly is of paramount importance and it should not put a spanner in the works of an online business. To stay up to date in the subscription business world means that automation and efficiency should be a top priority. Global businesses must have the tools needed to address local differences and challenges seamlessly. A way to navigate through the mine-field that is tax is to establish a cloud-based solution that eliminates the need for an in-house sales tax server. Such a solution would provide up-to-date and accurate data for calculations based on geolocation (latitude/longitude) rather than overly simplistic ZIP codes, as well as returns functions for ongoing compliance automation. This solution frees a company’s management from administrative and operative tasks allowing them to spend much more time on improvements, marketing and innovation to drive success. 

       With all this in mind, it has become apparent that tax is no easy aspect of daily business functions. Subscription businesses which are planning for the future will be headed towards an automated world and tax should be no exception to this. Businesses are working hard to transform manual workflows into automated ones, which can always be enhanced and improved as technology progresses. A well-integrated system should enhance all areas of a business and tax compliance must not be an exception. Automation is a concrete survival tool in a world of volatile markets, not just to save money and time, but also to stay creative by freeing up workflows. This is why savvy companies are looking for methods of streamlining operations, spreading costs more evenly throughout their organisation, and implementing an effective recurring billing strategy. Organisations using software or services to support their subscription and recurring billing migration need to consider implementing a robust platform to handle sales tax on-demand.

 

– Feb 21, 2020

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