by Michael Whitener, VistaLaw
For most of us, the tax man has already come and done his damage for the tax year, taking his allotted pound of flesh from our personal and/or corporate accounts. So with memory of that pain still fresh, it may be worthwhile to look at how a specific type of tax—the value-added tax (VAT)—applies to sales of Software as a Service.
In an earlier article, we looked at the impact of U.S. sales taxes on software transactions, including delivery of SaaS. We saw that this area is very murky, but that an increasing number of states are reaching for additional revenue by determining that SaaS is taxable as software, rather than nontaxable as a service. Even so, if a SaaS provider is out of state, the US Constitution requires that the taxing state prove a “nexus,” or sufficient connection, with the state before taxes can be assessed.
VAT is different. First of all, it’s helpful to understand the distinction between VAT (sometimes also referred to as a “goods and services tax”) and a sales tax. A sales tax is levied on consumers based upon the total value of goods and services purchased. In my state of residence of Maryland, for instance, the sales tax on most goods is 6%. A VAT is also a tax on consumer items, but it is levied on producers rather than consumers. At each step in the production process, producers pay a tax on the products they make. The biggest distinction between the two is that a sales tax is a direct tax, whereas VAT is indirect. As a result, a sales tax is obvious, in that it appears as a separate line on a receipt. VAT is less transparent, in that the VAT is wrapped up in the product’s purchase price, so it is harder for consumers to tell what portion of the prices they pay are due to taxes.
On a global basis, VAT is very popular with politicians as it provides a revenue gusher into government coffers that’s hard to track directly (a sales tax is far more in your face and its impact on your pocketbook is immediately felt). More than 130 countries around the world impose VAT on sales transactions. The United States has resisted joining this throng. President Obama did propose a national, but he met with strong resistance from Congress (and many economists) who didn’t feel that adding a national 15% to 20% surcharge on purchases combined with the federal income tax as well as state income and sales taxes would do the economy much good.
One thing that VAT has in common with sales tax is that VAT was not developed with SaaS in mind. So understanding how VAT applies in the SaaS context can be devilishly difficult.
To simplify matters, let’s take a specific situation. Let’s say you’re an American SaaS vendor providing services to customers in European Union member countries where VAT is imposed and see how the VAT rules will apply.
- First, you should know that, if you’re doing business in Europe, your sales are potentially subject to the VAT. Unlike in most US states, there is no general exception for the sale of software services, and there is no requirement for a nexus with Europe other than the existence of a customer there.
- Second, you have to look at how SaaS is defined for VAT purposes. SaaS falls under the VAT rules regarding “electronically supplied services.”
- Third, you have to consider whether your customers are (1) private European consumers or (2) a VAT-registered business. Let’s look at the two cases.
Customers are private European consumers or non-business organizations: You wail be subject to EU VAT rules implemented in 2003, which means that, in most instances, you will be liable for charging EU VAT on the invoices to your European customers. (The 2003 rules were aimed at “leveling the playing field” between EU-based software service providers, who had to collect VAT from their customers, and their US competitors.) It will be necessary for your company to:
- Register for VAT in one of the European countries (fortunately, EU rules do not require registration in every country where you’re doing business).
- Assess (charge) VAT on all of the invoices to the private consumers located in the EU countries. The VAT rate will differ by country, but generally range from 15% to 25%. For example, for UK customers it will be 20%, for German customers 19%, and for French customers it will be 19.6%.
Customers are VAT-registered businesses: You’re in luck—in this case, you’re not required to charge VAT or obtain a VAT registration.
If you are required to obtain a VAT registration, it’s not a costly or time-consuming process, but there are compliance costs of keeping VAT records and filing VAT returns. On the plus side, registration allows you to get refunds of any VAT paid on purchases and imports, because businesses are supposed to be tax collectors, not taxpayers.
The 2003 rules do offer non-EU businesses the option of registering electronically in a single Member State of their choice and accounting for VAT on their SaaS sales to all EU consumers on a single quarterly electronic VAT declaration that provides details of VAT due in each Member State. This declaration is submitted with payment to the tax administration in the Member State of registration and that State then distributes the VAT to the Member States where the services were delivered.
There can be heavy penalties in the EU for getting the tax rules wrong and failing to collect VAT as required, so be sure you get competent tax advice from an EU-experienced tax expert if you’re doing business in Europe. (Required disclaimer: Don’t rely upon this short article, which is not intended as, and should not be taken as, legal advice regarding VAT.)
If you’re a SaaS firm in Europe looking to do business in the US, VAT can offer your bottom line some unique challenges. For European SaaS companies, recent changes in EU tax regulations make things even more interesting than they normally are. If, for example, you’re an Irish SaaS firm you are not, in theory, required to collect VAT from a US-based firm, unless the US firm has a physical presence in Ireland (i.e. a business unit, subsidiary, division, etc.). However, in theory, you are expected to gather tax ID information from the US business.
The table below provides a quick guideline to how the rules currently apply; (visit www.revenue.ie/en/tax/vat/leaflets/place-of-supply-of-services.html for more information on the topic):
|SaaS Company Country||SaaS Subscriber Country||Customer Type||Place of Subscription||Entity Liable to Collect Irish VAT|
|Ireland||Other EU State||B2B||Other EU State||No Irish VAT collected|
|Ireland||Other EU State||B2C||Ireland||Irish VAT collected by SaaS firm|
|Ireland||Outside EU||B2B||Non-EU State||No Irish VAT*|
|Ireland||Outside EU||B2C||Depends on the nature of the SaaS service**||Irish VAT collected by SaaS firm|
* While a non-EU state doesn’t have to collect VAT, it does have to obtain a valid tax ID number from its international customer base. The odds that small or medium-sized US firms will provide this information to a company outside the US are about zero.
** The list of B2C industries exempted from Irish VAT include telecom, advertising, salt (yes, salt), IP property protection, and “electronically supplied” services.
I’ll close by mentioning another angle on SaaS and VAT—namely, that business accounting solutions offered via SaaS, such as Netsuite’s, can respond quickly when there are changes to VAT, such as when the UK government cut its VAT by 2.5% (from 17.5% to 15%) to stimulate business during the financial crisis, and then jacked the VAT up to 20% when it decided that the financial crisis was over.
Netsuite was able to change its software to address the change in VAT overnight. Customers of on-premise software had to wait for a patch to be installed. Netsuite trumpeted this advantage in press releases, noting that its customers doing business in the UK “will continue to enjoy full business systems compliance with the upcoming changes in the VAT without lifting a finger.”
Nice to see some good for the SaaS industry coming out of revised tax laws for a change!