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Why is sales tax so hard to get right for SaaS?

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Last Updated

Why is sales tax so hard to get right for SaaS?

Anrok | Streamlined sales tax for SaaS

If you are a finance leader or executive at a software company today, chances are you have heard of the new burden of sales tax. After the 2018 South Dakota v. Wayfair Supreme Court ruling and the expansion of economic nexus principles to sales tax, startups and technology incumbents alike have to monitor sales across all states regardless of physical presence. Sellers must determine whether they are liable to collect sales tax and if so, calculate the appropriate local rate. Over 20 states tax software or services related to software. For SaaS companies who have customers everywhere, this is no easy task.

In addition to the introduction of economic nexus in 2018, the rise of remote work, lack of complete customer addresses, and the nature of digital subscriptions, complicates matters further. Getting any of these pieces wrong may result in an inaccurate sales tax assessment and loss of revenue. 

The good news is that with the right tools, managing tax on software can be straightforward. At Anrok, we have built a sales tax solution specifically for subscription business models and treat economic nexus and physical nexus—including your remote employee footprint—as first-class concepts. 

We created this guide to cover three common challenges SaaS companies face, and how you can address them to set your company up for success.

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Table of contents

Challenge 1: Connecting your tax engine to your financial stack

SaaS businesses often have some combination of invoiced and self-serve revenue. To manage this, finance leaders use multiple tools to fulfill their invoicing, billing, and payment tasks. Many of these tools will need to connect to tax calculation software and retrieve the appropriate tax amount. Anrok integrations are designed to work with Internet subscription models and their financial stack out of the box.

For invoiced revenue—where an enterprise customer receives an invoice created by the billing team—an automated solution like Anrok can add the appropriate tax rate based on a customer's address. In this case, your system creating the invoice will need to communicate with your sales tax solution. The customer can then review the invoice, approve the amount, and remit payment.

For self-serve revenue—where a customer visits your website and proceeds with the purchase online—tax calculation is required in the checkout flow. In this case, your payment system will be initiating the call to your sales tax engine.

In addition to fetching tax rates across multiple tools, you will also want to aggregate your tax obligations and organize them by jurisdiction. Anrok records all of your transactions in one place and automatically generates tax returns that are filing-ready. No matter how your financial stack evolves, your sales tax filings will be centralized and clear in the event of an audit. 

Challenge 2: Accurately locating your customers

“But I don’t know where my customers are!” is a common reaction amongst SaaS businesses tackling sales tax for the first time. The typical transaction in the US follows the destination-based sourcing method, where the sales tax amount is calculated based on where the customer “receives” the item sold. Unless you are a SaaS business doing pure enterprise and invoiced sales, you are unlikely to have accurate addresses for all customers.

While it is best to have the full customer address along with the 9-digit zip code, some states recognize that this is not always feasible. Thankfully, there is a hierarchy that most states and countries will adhere to.

If the credit card 5-digit zip code is all you have, you'll need a tax engine with a sophisticated enough address validation system to account for such situations. This is crucial to ensure that tax is calculated instead of dropped or rejected. If you have any self-serve revenue or sometimes lack the full customer address, make sure your tax engine can work with the address data you have and account for all your transactions.

Challenge 3: Updating tax when invoice amounts change

When subscriptions are seat-based or consumption based, invoice amounts can change and are often subject to true-ups. This is where legacy tax engines—which are built for isolated transactions—break down. There is no customer lifecycle concept or way to associate transactions.

Digital subscription businesses go through numerous updates in any given invoicing period. The two key factors to look for in an automated solution is whether (1) you can customize your tax engine to align with when your true-ups happen, and (2) you can view associated transactions on the platform for when you come to do revenue reconciliation.

Anrok provides finance leaders powerful configuration tools to set when their filing period ends to align with their billing processes. Let’s say you bill on a volumetric basis and only measure customer consumption every 48 hours. You can time Anrok to close your returns in step with when your billing system recognizes true-ups. With configurations that adapt to your process, you can trust that Anrok has all the relevant transactions for the tax period and can file accurately on your behalf.

Modern software companies deserve a modern tax solution. The new demands of monitoring revenue thresholds and remote employees coupled with the unique nature of digital subscription billing models mean that the Internet era has fundamentally different tax needs to traditional retail. Anrok was designed from the ground up for Internet companies that need to manage tax on software.

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