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How sales tax rules apply to software and other digital products

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Last Updated

How sales tax rules apply to software and other digital products

Anrok | Streamlined sales tax for SaaS

If you’re a business selling software, it’s essential to know how tax authorities in US states and countries around the world will classify your products. Software is a particularly complex category in tax law, in part because it’s a relatively new type of product and continues to evolve in ways that tax departments have difficulty keeping up with. The same goes for other digital products like streaming video, gaming, and NFTs.

From a tax perspective, it can be difficult to make the distinction between digital products, especially SaaS (Software as a Service) and other types of software. But knowing how your product is classified is important for your sales tax and VAT management process because each jurisdiction might tax various types of software differently.

The wild world of digital product taxability

Making sure you’re compliant with sales tax and VAT regulations starts with understanding your product’s taxability, everywhere you have customers or employees. But that’s no easy feat, given that each jurisdiction has its own specific rules for taxing digital products—and they rarely agree on the definitions of different types of software.

In the US, for example, there are some states, such as Tennessee, New Mexico, and South Dakota, that levy sales tax on all sales of software, no matter which kind. But most states have more complex rules.

States might distinguish between “canned” software, which is standardized software customers buy “off-the-shelf,” and custom-made software that is particular to the customer. In each of those cases, the state may distinguish whether those types of software are delivered on physical property or are made to be downloaded. Some states distinguish between canned software, custom software, and canned software that has been customized. SaaS is typically seen as separate from any of those scenarios and has its own tax rules.

To give you an idea of how different states’ rules can be, check out these examples:

  • Virginia exempts software, whether custom or prewritten, when the software is transferred electronically to the customer.
  • California only taxes software that is canned and is delivered on or includes a physical medium.
  • Texas considers SaaS to be a data processing service, which is taxed at 80%.
  • Washington taxes SaaS but considers data processing to be a non-taxable service.

Internationally, classifications also vary widely. Some countries provide specific definitions for which digital good and services tax applies to—for example, in Europe a product is typically considered a digital good or service if it:

  • is delivered over the Internet or an electronic network
  • is essentially automated and involves minimal human intervention
  • would not exist without technology
  • is not a physical good

But other countries, like Australia and New Zealand, simply apply tax to all remote services provided to customers in their countries.

Not only do states and countries differ in their laws governing software, but those laws can and frequently do change as authorities work to keep up with changes in digital product delivery. It can be extremely challenging for software companies to ensure they are charging the right amounts of sales tax and VAT in the right places.

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Table of contents

Is your product taxable as SaaS?

Many modern software products fall into the category of SaaS, or software that customers access remotely via the internet and pay for on a subscription basis. But it’s not always easy to correctly categorize SaaS and other types of software. Read on to learn the biggest differences between them.

Location and accessibility

If your software is SaaS, then anyone, anywhere with a connection to the Internet can access it. This means that multiple organizations can access the software hosted on the same network at the same time. By contrast, on-prem software is hosted on hardware physically accessible to the customer and only available on devices that have access to that local network.

Licensing and payment methods

Another major difference between SaaS and traditional software is the way that people purchase it. SaaS is a subscription-based service; customers pay a service fee for access to that software. Meanwhile, traditional/on-prem software is typically purchased up-front through a licensing agreement.


The provider of SaaS software remains the owner of all hardware and software, and is also responsible for maintaining and updating the software over time. With SaaS, the customer owns only their own data in the system. With on-prem software, on the other hand, the customer owns all aspects of the solution: hardware, software, and data. All maintenance and updates are also the responsibility of the customer.

Choosing the right tax category for your digital product

You may have other digital or cloud-based products that fall outside the definition of SaaS. These can include Platform as a Service, digital goods, web hosting, domain name services, data processing, and information services, among many others.

The definition of each of these varies by state and country, which can make things even more complicated when trying to determine the taxability. For example, data processing services are not taxable in Washington, while Texas clearly states that SaaS is included as a data processing service and both are taxable. Because of the difference in taxability across jurisdictions, it is incredibly important to understand what category your product falls under.

Here’s a high-level reference of the different tax categories for software and other digital products. Keep in mind that the way each category is taxed can differ across countries, states, and even city or county lines—and that the rules in each jurisdiction are subject to frequent updates as tax authorities continue efforts to modernize their tax codes.

  • SaaS (software as a service): Subscription-based access to electronically delivered software.
  • Digital goods: Typically describes traditionally physical goods now delivered electronically. This category includes products like ebooks, streaming music and video, gaming, and NFTs.
  • PaaS (platform as a service): Cloud-based software bundles that include both infrastructure (servers, storage, and networking) and the middleware (development tools, business intelligence services, database management systems). 
  • Cloud services: Infrastructure as a service offering, providing users remote access to data center equipment and computing power.
  • Digital services: A broad category that includes products like data processing, information services, domain name services, and web hosting.
  • People services: A broad category that includes products like training, professional services, and implementation services, whether bundled with other digital products or sold separately.
  • Downloaded software: Traditionally downloadable software that does not have a physical component (like a CD-ROM).

Needless to say, keeping up with changing taxability, rates, and other regulations across the globe is a lot of work. An automated sales tax engine like Anrok can help substantially, making the process as easy as clicking a button. With a global tax solution in place, you can rest easy knowing you’re charging taxes in line with the latest state regulations, no matter what kind of software you sell.

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