In this guide you’ll learn:
Taxes - they might not be your first consideration when selling internationally; but without fully weighing up the tax implications of selling in an entirely new country you could find yourself losing out legally and financially.
Through this article, you’ll gain an understanding of what kind of infrastructure you’ll need to have in place to maintain a tax compliant business. Keeping up with the complex world of tax regulations will ultimately allow you to make the right decisions when expanding.
In this long-read, we’re going to take you through the key global tax territories. Detailing how to approach their unique tax systems and the main changes that have been implemented in recent years for those selling to B2B and to B2C. The countries we’ll focus on within this article are:
The United States
We finally look at the practical resources you can use to keep up-to-date with the latest tax developments and offer a solution for your tax hassles while staying legally compliant.
Our tax knowledge in this long-read comes directly from our in-house tax experts, who ensure that Paddle and our sellers are following the latest tax laws and regulations globally.
Tax info to know before you grow
A common misconception about selling to new countries is that if you’re not physically setting up a new office there, you don’t have to worry about tax. Well, even if you have no physical presence in a country, it doesn’t mean you shouldn’t be charging sales tax there. Being tax compliant isn’t just a question of calculating the right amount of tax in your checkout or on invoices. Even within different parts of the same country, you’ll find differing legislation on:
The evidence you need to retain for potential audits.
Whether filings are monthly, bi-monthly, quarterly, semi-annually or annually.
The need to pay in the local currency of the country.
That’s a lot to take into account when working out your taxes. If you think it's all too much effort and choose to be non-compliant, the penalties can be severe. You’d pay back taxes for the period you should have been compliant (potentially going back many years), plus interest and possibly other penalties. Countries like India even offer jail time for those who are non-compliant.
Are you selling as B2B or B2C?
Sales Tax on digital goods, software, and SaaS products has now been introduced in more than 40 countries around the world. In some countries, it’s applied to both private individuals (B2C) as well as customers registered as businesses / legal entities (B2B).You may wonder how you’ll be taxed selling B2C or B2B? Well, when selling B2C transactions are usually taxable depending on the territory you’re selling to. Whereas B2B is not always taxed but in some jurisdictions (most notably the US) it is. Within the EU, it's important to note that the definition of B2B isn’t just “any business” but “a VAT-registered business,” so you may be selling B2C in the EU without even knowing it.
Sanctioned markets to beware of
We won’t go into too much detail on the sanctioned markets (places that have been banned for political or security reasons), as we have a list of unsupported countries to refer to. Our recommendation is to research the dangers of working with sanctioned countries to see the detriment it would cause to your business.
Tax trends impacting the world
Sales tax has been at the heart of recent major tax trends, as more companies are adopting more of a stance on selling software online.
The European Union’s 2015 introduction of VAT MOSS means that tax needs to be charged where the customer is based, as opposed to where a company is headquartered or operating (which is defined as 'physical nexus'). This move has led to a number of other countries following suit, many of which have no or very low tax thresholds. Both China and Canada are also on the pathway of ‘digitalisation’ in their taxes, so changes are expected to happen there in the near future.
Looking further afield, a VAT system has been adopted for the first time in the Middle East in 2018, covering all Gulf Cooperation Council countries, which includes Arab states of the Persian Gulf except Iraq. In the last four years, countries like Japan, South Korea, Australia and Russia have also started requiring overseas sellers to register for sales tax.
Within the US, the most significant change has been the South Dakota vs. Wayfair ruling which means that non-US businesses have to start charging sales tax when above certain thresholds based on a concept called economic nexus. Now with the latest ruling, states have the power to use these laws to tax online businesses. The ruling will have a significant impact on how software is sold in and outside of the US due to of the varying degree of adoption across the states. For more information check out our recent explainer on the subject.
Key global tax territories
Now that we’ve covered what should be considered before you expand, let's look at the countries you could expand to and the requirements of operating in their legal jurisdictions. The key aspects to take into account are the territory’s tax system, ongoing major trends and the difference when selling to a business or consumer in that territory.
The United States is a major market, expansion to which can lead to major rewards if done right. You’ll need to be vigilant to stay tax compliant across all fifty states.
Figuring out the US tax system
The biggest thing to note about selling to the US, is that it doesn’t have a blanket tax system when it comes to software. This is because software isn’t always taxable in all the states and different types of software sometimes fall under different tax treatments.
The cost of being compliant within the US will quickly add up. Even determining where you should be registered is a complex exercise which depends on the nature of your product and will require the advice of a tax firm (who will charge fees for each state they examine). Software delivered via a physical medium (CD or USB) is taxable in most cases. Applications which are downloaded are taxable in 80% of states, and cloud-based SaaS products are taxable in about 50% of cases. Once registered, you’ll need to work out a rate to use in each particular state, while keeping up with any changes in these rates.
Each state has a different filing system which means multiple filings. These filings you can do on your own at a considerable time cost or at a physical cost of tens of thousands of dollars annually if outsourced to a tax firm.
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 varies from state to state, but it is considered to be sales into a state exceeding a certain dollar threshold or a number of transactions.
There was no official change to the law, as it’s just an interpretation of the law and so South Dakota hasn’t had to pass legislation and has just adopted this new approach from the time of the ruling. Other states have been quick to jump on the bandwagon and now economic nexus has been adopted in over thirty states.
(Pennsylvania will be added from July 1st, 2019)
Our advice when selling to the US
The US is the biggest market for software in the world, so not selling there for tax reasons would be ill-advised. If you’re selling small amounts into each state, then you’ll probably not need to worry too much. However, if you hit the existing thresholds in some or most states, the costs to be compliant can be astronomical if you do it yourself, with the process being hugely complex and time-consuming. This may all sound very bleak, so if you’re looking for a direct solution when selling to the US jump to our final section.
Selling to Canada
You may be asking yourself “what is sales tax in Canada?" Well, the Canadian tax system is very similar to how the US system used to be, as all but one of Canada’s states employ the concept of ‘physical nexus’ and 'economic' nexus. Which means that you need to have premises, employees or salespeople in the state before you’re required to register for sales tax. The exception to this rule is in Quebec state where, as of January 2019, the distance selling of software is now 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. Your priority should be finding a checkout that can distinguish between zip codes, otherwise you’ll be charging everyone in Canada needlessly.
Selling to China
China has introduced new tax rules which came into effect at the beginning of this year. These rules deal mainly with cross-border physical goods sold into China via electronic platforms (e-commerce). No tax system that deals with electronically supplied services exists yet, so it’s outside of scope of the sales taxes for anyone who’s selling their software into China from across the border.
The primary consideration when selling into China shouldn’t be tax. Selling software and particularly SaaS into China is problematic as the Chinese state can block any product which is hosted on non-Chinese servers or not approved by Chinese regulators. To sell in any volume to China requires a Chinese entity or a partnership with a Chinese company.
Selling to the EU
Selling within countries of the European Union (EU) you’ll find software is taxable at different rates. So, if you want to be compliant, you could register and file in countries where you sell, but for most businesses that would be a pain, meaning you would have to do numerous filings every quarter in the countries where you’re selling software to.
How to deal with VAT MOSS
When approaching the idea of selling within Europe, you may have come across the term VAT MOSS. Apart from being all-caps terrifying, it's essential to understand it's implications if you’re looking to expand to Europe.We’ve talked about the impact it had when it was first implemented, but to recap the timeline, VAT MOSS came about in 2015 when the EU changed the VAT rules governing software. Before that point companies (like Apple or Google) could set up their EU HQ in Luxembourg and take advantage of its low rate of VAT, applying this to all their EU sales.The introduction of VAT MOSS meant that the rate of tax charged became the rate of the country in which the customer was based, the purpose being to have a means for companies to make filings for all EU sales from their home country (or designated country if they’re a non-EU business).
What was once a super quick process soon became very complicated. The main problem being that 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
When looking to sell to the EU, it doesn’t matter whether you’re based in or outside the EU as long as you make an equivalent of €10,000 in annual sales into the EU. You then have to register for VAT and start charging your customers.
If you’re a B2C company, then you don’t need to be selling much to fall under the VAT regime. VAT always applies to B2C 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 28 member states, something which your checkout should be built around.If you’re a B2B company, then you should be okay selling to 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 €10,000 in the whole EU area. 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.
Post-Brexit Britain anxiety?
With the talk of a ‘hard Brexit,’ you may be slightly worried about the prospect of selling UK software to the EU market. But you can breathe easier as, from a tax perspective, there will be little change to no change. UK VAT will still need to be applied to sales into the United Kingdom, although the tax filings may look slightly different.
The main change expected is that all UK businesses currently registered for VAT MOSS may have to move away from the union scheme (currently available to EU businesses only) and register for a non-union MOSS system that will apply once the UK leaves the EU. UK businesses selling to B2B customers will have to validate the VAT numbers for EU and UK separately, something currently covered by the EU-wide VIES system.
Becoming tax independent
We’ve covered tax territories and the main myths, now let's explore what you can practically do to face your tax concerns head-on when expanding. What we’re discussing may seem quite daunting, but it’s only the tip of the global tax iceberg. In this section we’ll show how you can practically assess your tax exposure by finding resources to keep up to date with tax trends. Additionally, we’ll outline a solution that will ease your tax stress while keeping you legally compliant with your chosen jurisdictions. This model allows you to place the responsibility on your payment provider to handle the taxation of the jurisdictions you’re selling in, leaving you hassle-free.
Finding your tax resources
You may be wondering where you can find info about tax exposures and keep up-to-date with the latest developments. We recommend going region specific for your tax information.
For the US, you should know which States have adopted economic nexus in light of the recent ruling, a detailed analysis into which type of software is taxed in each state will require state by state research.
When dealing with Europe, the UK government has a pretty easy to understand site dealing with EU VAT on software. For other jurisdictions, you’ll need to use a combination of the government’s websites and Bulletins from global tax advisory firms (such as PwC or KPMG).
The solution you’re looking for
If you’re still contemplating doing this alone, you’ll need to register in numerous countries, charge the correct amount of tax while dealing with all the filing and payments yourself.
There are plugins available that you can use to calculate your taxes. They won’t, however, deal with filings or payment automatically - these come at an added cost and could amount to tens of thousands of dollars each year.
A Merchant of Record (MoR) model may be the answer to your problems. A MoR acts as a reseller of your software, which means that each sale to an end customer is legally a concurrent sale from you to the MoR and from the MoR to the customer.
Basically, this means that the sales tax obligation always resides with the Merchant of Record. You do not have to worry about sales tax in any jurisdiction. The MoR has the registration with the tax authorities, calculates the right amount of tax to charge any customer, handles filings and payment and is the person the authorities go to if there is an audit. By using a MoR (like Paddle) all you have to do is just sell your product and let the MoR do that tax work for you.Sounds daunting? A Merchant of Record like Paddle will handle all of this for you automatically, so you can focus on running and growing your business.
We hope you’ve enjoyed this long-read and have taken away some valuable insight on tax when expanding. Hopefully we’ve shown you that tax is something to always consider when selling to new territories, being aware of each territory’s tax system and your personal tax exposure when selling there.
The three main points to take away from this piece are:
The penalties for not paying tax can include jail time.
US sales tax is changing in a big way and you’ll need to stay compliant when selling there.
A merchant of record model can sell on your behalf and handle your tax.
If there are any other topics which you’d be interested in us covering, especially around taxes, tweet @PaddleHQ with your opinions!