Sales tax is a consumption tax imposed on the buyer during the point of sale of a product/service, collected by the seller, and paid to the government.

How does Sales Tax work?

Sales Tax is usually charged only to the end customer, during the purchase of products and services from a business. This is followed so that businesses that are intermediary don’t end up paying the entire tax that is charged on top of the final product. Sales Tax is similar to a Value Added Tax collected on goods and services.

Take the example of a Teak company that sells raw Teak wood and an end-user who wants to buy a chair. However, there are businesses in-between that help in manufacturing and selling this chair that isn’t the end users. To prove that, they must obtain a resale certificate from the government stating that they are not the end-users of the product so that they don’t pay the tax charged on the chair.

Does Sales Tax affect your SaaS business?

A SaaS business selling products in a particular region is obligated to follow the sales tax of that region. Your business must verify if your SaaS product falls under either of the following classifications of taxable software:

Canned software: an off-the-shelf software solution that can’t be altered
Custom software: custom software solutions that are developed on top of canned software.

Another important rule to be followed is to check if the region recognizes a ‘Nexus’ on your company. A Nexus is a ‘tax presence’ of your business in the region you sell your product in. It refers to the connection between your business and taxing jurisdiction of that region. It can be your business established in that region, or having employees/affiliates in that region. Each region has its own rules for determining Nexus.

If the SaaS company fails to charge sales tax on their product, a hefty fine will be imposed on that company - and that may lead to a severe penalty. In order to be compliant, your business needs to abide by the tax code of all regions that you sell to.

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