Sales Tax on digital goods, software, and SaaS products has now been introduced in more than 40 countries around the world. These taxes don’t follow a standardized system so it’s important for businesses to understand the regulations in the jurisdictions they’re selling to.
In this guide, we’ll look at the tax regulations in key global markets and discuss what’s involved for software businesses managing sales tax compliance, globally.
Key tax considerations when selling software internationally
Where do you need to pay sales tax?
Sales tax on software works differently to the way it does for e-commerce and physical goods.
The main difference is that the taxes apply not only to where your company has a physical presence (an office or employees) but to where your customers are based.
Tax jurisdictions exist by country or in some cases, like the US, each state, and even county or city will have its own legislation on:
Taxable goods: Each jurisdiction has its own legislation on which products and services are taxable, with more and more countries adding software and digital goods to the list.
Threshold and tax rate: The amount of sales you need to make before tax is due and the amount you need to pay.
Audits: What evidence you need and how long you need to keep records for.
Filing and remittance: How often you need to file taxes, (e.g. monthly, bi-monthly, quarterly or annually) and the method of payment (including whether or not you need to pay in the local currency of the country you’re paying in to).
Penalties for non-compliance: Ranging from backdated payments with interest (for as long as you have been non-compliant) to additional fines and even criminal charges, where non-compliance is thought to be malicious.
Are you selling B2B or B2C?
In some countries, there are different rules for the sales tax on digital goods, software and SaaS products depending on whether your customers are:
Private individuals (B2C).
Customers registered as businesses or legal entities (B2B).
B2C transactions are usually taxable depending on the territory you’re selling to. B2B is not always taxed but in an increasing amount of jurisdictions (most notably the US) it is.
It’s also important to note that not all jurisdictions have the same definition of a business customer. Within the EU, for example, rather than “any business” it applies to “a VAT-registered business”. This means you could have tax obligations to people you think are businesses but from a tax perspective they are considered consumers.
Sanctioned markets to beware of
In accordance with anti-money laundering and international regulations, there is a list of sanctioned or restricted markets that you should be aware of if you plan to sell internationally. Countries have been placed on this list for political or security reasons so it’s more than likely these markets won’t be supported by payment providers, compliance tools or merchants of record.
Tax trends impacting the world
More companies than ever are selling software globally – many of which offer subscriptions via the cloud rather than a physical disc or drive. As more and more companies take this approach and the subscription economy continues to thrive, tax authorities in major markets have been forced to keep up, with new regulation in the US, European Union and the Middle East leading the charge:
VAT MOSS – Introduced by the European Union in 2015, VAT MOSS requires you to charge tax where the customer is based, as opposed to where a company is headquartered or operating (has a “physical nexus”). Since 2015, a number of countries outside Europe have introduced similar regulations, many of which have no or very low tax thresholds .
VAT system in the Middle East – First introduced in 2018, this system covers all Gulf Cooperation Council countries (Including Arab states of the Persian Gulf except Iraq). Over the last few years, countries like Japan, South Korea, Australia and Russia have also started requiring overseas sellers to register for sales tax.
The South Dakota vs. Wayfair Ruling – This ruling introduced the concept of “economic nexus”, meaning that Sales & Use Tax is applicable when sales into a state are above a certain threshold – regardless of where the business is based.
Key global tax territories
To manage sales tax successfully, you need to comply with the regulations specific to the countries or states you operate in.
Below, we look at some of the biggest global markets and the requirements for selling software in their legal jurisdictions.
The United States
The US doesn’t have a blanket tax system for the sale of software. In fact, states, counties, and even cities have different regulations – totaling over 11,000 tax jurisdictions that businesses to be aware of!
Software is taxable at different rates in most states and even different types of software or digital goods can fall under different tax treatments.
This can quickly become confusing! For example, in New York, electronically downloaded software and SaaS are taxable but digital books and other digital goods are not. Whereas in Colorado, electronically downloaded software and SaaS aren’t taxable but digital books and other digital goods are.
Software delivered via a physical medium (CD or USB) is taxable in the majority of states.
Downloadable applications are taxable in 80% of states.
Cloud-based SaaS products are taxable in about 50% of states.
If you do sell into the US, your pricing should be advertised net of VAT.
This is because the differing tax rates across jurisdictions have a significant impact on the gross total.
How economic nexus is changing the US tax system
Up until June 2018, unless you had “physical nexus” in a US state (premises, employees or freelance salespeople), there was no obligation to register for Sales & Use Tax in that state. That ended with a Supreme Court judgment (South Dakota vs. Wayfair) which ruled that Sales & Use Tax could be based on “economic nexus”.
“Economic nexus” refers to sales into a state, regardless of where the company is based. The terms vary but usually tax liability starts when sales into a state exceed a certain dollar threshold and/or a number of transactions.
The ruling wasn’t an official change to the law but an interpretation of it. As such, South Dakota didn’t pass new legislation but adopted this approach from the time of the ruling. Since then, “economic nexus” has been adopted by the majority of other US states.
Managing US sales tax
From determining where you should be registered to filing and remitting tax payments in each jurisdiction – managing sales tax in the US is a complex process.
To understand where you are liable for sales tax, and complete the registration process, you'll need either a tax expert inhouse or the advice of a tax firm (who will charge fees for each state they examine).
Once registered, you’ll need to know the right rate to use in each jurisdiction as well as how to file and remit tax payments – while keeping up with any changes as they come into effect.
You need to have premises, employees or salespeople before you’re required to register for sales tax in most Canadian states.
The exceptions are Quebec state and Saskatchewan where the distance selling of software is taxable.
If you don’t have a physical nexus in any state but you do sell B2C into Quebec state, then you have to be compliant if your total turnover in the state exceeds the current threshold of 30,000 CAD over a period of twelve months. In Saskatchewan, there is no threshold, meaning businesses are liable from the first sale.
To sell software in Canada, your checkout should have the ability to distinguish between zip codes, so you don't make mistakes and charge some customers unnecessarily.
It’s also important to remember that the regulations for sales tax in Canada are subject to change. If you sell into any Canadian state, you need to make sure you’re aware of any updates as and when they come into force .
China introduced new tax rules at the beginning of 2019. These rules deal mainly with cross-border physical goods sold into China via electronic platforms (e-commerce).
Currently, there isn’t a tax system that deals with electronically supplied services for businesses selling software into China from across the border. However, as in Canada, this is constantly under review and changes to sales tax regulations for digital goods and software are expected in the near future.
Even without tax liability, selling software and particularly SaaS into China is difficult as the Chinese state can block any product that isn't hosted on Chinese servers or hasn’t been approved by Chinese regulators. To sell in any volume into China, you’ll need to have a Chinese entity or a partnership with a Chinese company.
The European Union
Countries in the European Union (EU) tax software at different rates. These taxes are paid through a system called VAT MOSS.
Understanding VAT MOSS
The introduction of VAT MOSS in 2015 means that the rate of tax charged in the EU is the rate of the country in which the customer is based, rather than the company making the sale.
This stops companies from being able to set up their EU HQ somewhere with a low tax rate, like Luxembourg, and apply this rate to all of its EU sales.
As a result, companies have to make filings for all EU sales from their home country (or designated country if they’re a non-EU business). This complicated the filing process as software companies suddenly had to know what rates of VAT to charge in each country within Europe, collect and retain evidence of each sale and then allocate sales by country for their filings.
Selling from inside and outside the EU
Sales tax regulations in Europe are the same whether your business is based in or outside of the European Union.
For B2C companies, VAT always applies to sales within the EU. Compliance requires you to collect two pieces of non-conflicting evidence confirming the location of the customer and calculate the correct rate to charge in each of the 27 member states (this logic should be built into your checkout).
B2B companies may be tax-exempt in the EU unless you have non-VAT registered businesses or prosumers buying your products. In which case, you’ll need to collect VAT if these sales exceed the €10,000 threshold. For cross-border B2B sales there is no tax due – it is subject to the “reverse charge” which places the responsibility on the customer to pay the tax.
The main change, post-Brexit, is that from January 2021 UK businesses will not be able to use the UK’s current VAT MOSS system for sales into EU member states. You’ll need to either register for VAT MOSS in an EU member state or register for VAT in each member state that your business sells digital services into.
UK VAT will still need to be applied to sales into the United Kingdom, although the tax filings may look slightly different. For non-registered businesses, there isn’t a threshold for sales tax, meaning you’re liable from your first software sale into the UK.
Remember, this information is subject to change.
You can keep up with the latest information on sales tax in Britain, here.
Managing tax compliance
Once you are registered for sales tax, you need to be aware of any updates to existing or new regulations that come into action. To do this, you’ll need to follow the right resources to reference and make sure you’re still compliant.
We recommend going region specific for your tax information.
For example, for sales into the US, you should know which states have adopted economic nexus as well as the tax rates within each of these states. This will require research into the types of software taxable in the states you sell into, for example, by following each local tax authority.
If you’re selling to the UK, there is a simple site dealing with VAT on software . For jurisdictions across the European Union, you’ll need to use a combination of the government websites in each country and bulletins from global tax advisory firms (such as PwC or KPMG).
Routes to compliance
There are three broad approaches when it comes to managing tax compliance:
It’s possible for software businesses to manage sales tax internally. However, it’s time consuming and requires inhouse tax specialists to register for and then file and remit sales tax in every jurisdiction you sell to. Managing sales tax in house also means that your company is completely liable should it be found non-compliant.
Tax compliance tools
There are tools available (like Taxamo, TaxJar and Avalara) that you can use to calculate your taxes. They won’t, however, deal with filings or payment automatically – if these services are available, they often come at an additional cost. The charges are usually per filing and per jurisdiction, which quickly adds up when you’re selling globally. It’s also still ultimately your company that is liable for tax compliance, unless again, this is available at an additional cost.
Merchant of record (MoR)
With a Merchant of Record (MoR), the MoR acts as a reseller of your software and takes on any sales tax obligations on your behalf. This means that the MoR registers with the tax authorities, calculates the amount of tax to charge, handles filings and payment and is the entity that the authorities would go to in the event of an audit – leaving you free of any sales tax liability.
How Paddle can help
Operate with full integrity and compliance with the Paddle Revenue Delivery Platform.
As a reseller, Paddle takes on all tax liability for the transactions to all end customers, absolving you from any non-compliance.