Latest / Bennett Thrasher Presents: Beyond The Ledger / Is Your Software Business at Risk? The Hidden Risks Software Companies Can’t Afford to Ignore

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Is Your Software Business at Risk? The Hidden Risks Software Companies Can’t Afford to Ignore · Bennett Thrasher Presents: Beyond The Ledger

• 0:09
  SPEAKER_00: Welcome to Beyond the Ledger.
• 0:10
  SPEAKER_00: I'm your host, Shardet Layfield.
• 0:12
  SPEAKER_00: For software companies, growth can happen fast.
• 0:16
  SPEAKER_00: New customers, new markets, and new revenue streams.
• 0:19
  SPEAKER_00: But that growth can also create sales tax obligations that are easy to overlook and costly to ignore.
• 0:26
  SPEAKER_00: To dive more into the details, let's start the conversation.
• 0:30
  SPEAKER_00: Today I'm joined by Adrian Eccles, Director and Bennett Thrasher of State and Local Tax Practice to talk about the sales tax challenges facing SaaS and software businesses.
• 0:40
  SPEAKER_00: We'll unpack where companies commonly get caught off guard, how Nexus and Ta's ability can change from state to state, what to do when you uncover past exposure, and where automation fits into the compliance picture.
• 0:53
  SPEAKER_00: Adrian, welcome back to the show.
• 0:55
  SPEAKER_00: I'm excited to be here.
• 0:56
  SPEAKER_01: Hey Charlotte, good to be here again.
• 0:58
  SPEAKER_00: Congratulations on your director role, which is a very exciting news.
• 1:04
  SPEAKER_01: Thank you.
• 1:04
  SPEAKER_01: Thank you.
• 1:05
  SPEAKER_00: You're welcome.
• 1:06
  SPEAKER_00: So you ready to dive in?
• 1:07
  SPEAKER_01: I am.
• 1:08
  SPEAKER_00: All right, let's do it.
• 1:10
  SPEAKER_00: All right.
• 1:10
  SPEAKER_00: Software companies are built to scale fast, but sales tax rules don't exactly make scaling easy.
• 1:17
  SPEAKER_00: So where do you typically see a growing company, a growing software company first get caught off guard?
• 1:23
  SPEAKER_01: Yeah, that's a great question.
• 1:25
  SPEAKER_01: So as you're scaling, uh the first surprise is often that that quick growth creates can create a filing obligation before your tax team internally uh even realizes it.
• 1:36
  SPEAKER_01: So a company can cross economic nexus threshold through sales alone.
• 1:41
  SPEAKER_01: They could create physical nexus through an employee to travel.
• 1:45
  SPEAKER_01: So a remote employee working in that state that they hire on, where they're making sales, travel by their existing employees into that jurisdiction.
• 1:53
  SPEAKER_01: And sometimes uh third-party relationships.
• 1:55
  SPEAKER_01: Uh we've got something known as click-through nexus or affiliate nexus.
• 1:59
  SPEAKER_01: Um, and all those things can create a technical obligation and a filing obligation before you even realize you need to start charge of tax.
• 2:07
  SPEAKER_01: Uh, another surprise is product taxability at its core.
• 2:11
  SPEAKER_01: Uh, what a business refers to as SaaS can be treated differently uh by a state, and that can include things like pre-written software, sometimes data processing and information services, uh, digital products, or even some non-taxable professional services, configuration, implementation, things like that.
• 2:30
  SPEAKER_01: And when they get bundled, um, yeah, that creates complexity in and of itself.
• 2:34
  SPEAKER_01: And so each state has to be reviewed for how they treat all those specific underlying or subcomponents.
• 2:41
  SPEAKER_01: Uh, we often look at a contract and try to determine what the actual elements of that contract are and then assign taxability at that level.
• 2:49
  SPEAKER_01: So um going back to the sort of bigger picture question, I generally would recommend reviewing uh Nexus first and then uh product classification and then customer location data.
• 3:00
  SPEAKER_01: And we do that in what's known as a Nexus study.
• 3:03
  SPEAKER_01: Uh, and we would view invoices and contracts uh as part of that.
• 3:07
  SPEAKER_01: Rather than you know, treating anything or any state as just a standalone issue, we want to get sort of a holistic uh perspective on where you've got the filing obligation and make sure you know you're not creating exposure by continuing to make sales without registration.
• 3:22
  SPEAKER_00: Yes, it does sound complex.
• 3:24
  SPEAKER_00: But you've got a plan to like just solve all the issues.
• 3:28
  SPEAKER_01: That's it.
• 3:29
  SPEAKER_01: We've got a plan, absolutely.
• 3:31
  SPEAKER_00: All right, so let's play myth versus reality for a second.
• 3:34
  SPEAKER_01: Okay.
• 3:35
  SPEAKER_00: We sell software, so we don't really have to worry about sales tax.
• 3:38
  SPEAKER_00: How wrong can that assumption be?
• 3:40
  SPEAKER_01: Yeah, so keeping with the theme, I would say that's a myth.
• 3:44
  SPEAKER_01: Um, the assumption, that assumption's gotten a lot of folks in trouble with the various states' DORs.
• 3:49
  SPEAKER_01: Um, software in and itself is not really one uniform sales tax category.
• 3:54
  SPEAKER_01: And so then the answer on sales tax consequence or taxability determination is going to vary by state, your delivery method, the type of customers you sell to, uh, contract terms.
• 4:04
  SPEAKER_01: Uh, like I mentioned before, as an example, you know, like a hosted software platform might be taxable in one jurisdiction, could be exempted another, partially taxable, uh, subject to a reduced rate in some places, depending on the nature of that customer relationship, uh, what type of customer it is.
• 4:22
  SPEAKER_01: So, and even when the core offering isn't necessarily taxable on its face, um, other different elements that we've mentioned in the sort of contract review and underlying subcategory assignment, those things combined create this sort of bundling effect and it can change the result.
• 4:39
  SPEAKER_01: Um, the practical takeaway there is yeah, it's a myth.
• 4:42
  SPEAKER_01: Uh, and this general overarching, you know, uh idea that we just sell software, we we just sell services that are non-taxable, um is a good trigger for an analysis needed.
• 4:53
  SPEAKER_01: Uh, it should not ever be sort of the the conclusion to draw.
• 4:57
  SPEAKER_00: And what I hear is never assume.
• 5:00
  SPEAKER_00: Um things are always changing.
• 5:01
  SPEAKER_00: So if you assume and don't dig a little bit deeper or have someone that is an expert, you might you might just just re-revisit, revisit.
• 5:11
  SPEAKER_01: That's it.
• 5:12
  SPEAKER_01: That's it.
• 5:13
  SPEAKER_00: Okay, so two companies can sell what feels essentially the same software and end with very different sales tax obligations.
• 5:21
  SPEAKER_00: So, what details about how a product is sold or delivered can completely change the tax answer?
• 5:27
  SPEAKER_01: Yeah, it's a great question.
• 5:28
  SPEAKER_01: Uh, it's a little bit nuanced, but um, one one simple example where uh two companies sell what feel like the same software goes back to my example about the type of customer you sell to.
• 5:40
  SPEAKER_01: So, in a number of different states, there are B2B exemptions.
• 5:44
  SPEAKER_01: And so you might sell uh to one type of customer, and your competitor selling a very similar software sells to another type of customer, maybe a business, whereas you sell directly to an end user or one sells for resale, that can change the fact pattern and ultimately the taxability shifting from taxable to reduced rate to non-taxable, uh uh sort of across the spectrum based on your uh customer.
• 6:08
  SPEAKER_00: Okay, got it.
• 6:10
  SPEAKER_00: Okay, so here's a scenario.
• 6:11
  SPEAKER_00: A SaaS company is growing, customers are popping up across the country, and no one has really been tracking Nexus.
• 6:18
  SPEAKER_00: What would make you say, okay, we need to look at this like right now?
• 6:23
  SPEAKER_01: Absolutely.
• 6:24
  SPEAKER_01: Um, so I I like that you use the term uh Nexus.
• 6:28
  SPEAKER_01: No one's been tracking it.
• 6:29
  SPEAKER_01: That in and of itself is the trigger that yes, we do need to look at this.
• 6:33
  SPEAKER_01: So you do want to get your arms around your Nexus factors, economic and physical.
• 6:37
  SPEAKER_01: Uh physical could be, again, remote employees.
• 6:41
  SPEAKER_01: Um, it could be you know inventory, even inventory managed by 3PL.
• 6:46
  SPEAKER_01: Uh it could be a brick and mortar, it could be third-party relationships, uh, independent sales reps, subcontractors who hold open a market on your behalf.
• 6:54
  SPEAKER_01: Any of those things can trip physical nexus.
• 6:57
  SPEAKER_01: And then economic considerations.
• 6:59
  SPEAKER_01: So the general rule of thumb that folks that are you know sort of in the no will point to is gonna be$100,000 in gross receipts.
• 7:07
  SPEAKER_01: There are exclusions in certain states from your sales counting toward that.
• 7:12
  SPEAKER_01: Um, typically we look at that over a 12-month period, whether it's calendar year in some states, trailing 12 months.
• 7:18
  SPEAKER_01: Um, it just varies from state to state.
• 7:20
  SPEAKER_01: So getting your arms around Nexus is absolutely critical.
• 7:23
  SPEAKER_01: And right behind that is gonna be well, do we have a sales tax consequence transaction into that state?
• 7:28
  SPEAKER_01: So Nexus tells you if you've got an obligation, and then sort of categorization and understanding of your sales revenue streams tells you you've got exposure.
• 7:39
  SPEAKER_00: Ooh, got it.
• 7:40
  SPEAKER_00: Okay.
• 7:41
  SPEAKER_00: So what's a sales tax red flag that might look harmless on the surface but immediately gets your attention when you see it?
• 7:48
  SPEAKER_01: It's a good question.
• 7:49
  SPEAKER_01: Um, one might be maybe a material revenue stream that doesn't necessarily reconcile from invoicing system back to your ERP or doesn't reconcile from ERP to your sales tax software.
• 8:04
  SPEAKER_01: Um, sometimes you see that with companies who sell through marketplace facilitators or a number of different sales channels where you know you're not necessarily compiling all that data correctly to represent gross receipts on your returns.
• 8:18
  SPEAKER_01: Um and with that, when you're missing data, there's an under-reporting issue potentially, and then there's also then that tax consequence on that revenue stream.
• 8:27
  SPEAKER_01: So you've got a couple of different problems that can result from your systems not being configured correctly or talking to one another correctly.
• 8:34
  SPEAKER_00: Okay.
• 8:34
  SPEAKER_00: Thanks.
• 8:35
  SPEAKER_01: All right.
• 8:36
  SPEAKER_00: Let's say a CFO realizes the company may have several years of sales tax exposure.
• 8:41
  SPEAKER_00: There's probably an instinct to just start filing and fix it moving forward.
• 8:46
  SPEAKER_00: Why might that actually be the wrong first move?
• 8:49
  SPEAKER_01: It's a great question.
• 8:51
  SPEAKER_01: Something we encounter often.
• 8:52
  SPEAKER_01: There's often a lean in business decision making in the C-suite level in particular, toward, well, let's stop the bleed and get it right going forward and you know, um kind of let the rest fly into the radar.
• 9:04
  SPEAKER_01: It's never a good approach.
• 9:05
  SPEAKER_01: Um, and starting prospectively without understanding your history can really hamper your ability to take advantage of programs that exist to mitigate or lessen that historical burden.
• 9:18
  SPEAKER_01: Um, one of the ways that we resolve back exposure, historical exposure, um, that's identified in our Nexus and exposure reviews is uh entering into voluntary disclosure agreements with states.
• 9:31
  SPEAKER_01: What that does is it limits the look back for the state.
• 9:34
  SPEAKER_01: So you might have been selling for 10 years and have exposure for 10 years, but if we can approach the state and engage them in in a voluntary disclosure and secure that for a client, we can um stop the look back to statute limitations, which is typically three to four years.
• 9:52
  SPEAKER_01: So the complimentary or remaining six or seven years would fall off.
• 9:55
  SPEAKER_01: Uh that's barring any evidence of tech or instance of tax collected not remitted, of course.
• 10:00
  SPEAKER_01: But um that's one strategy that prospective filing will ultimately preclude you from being able to take advantage of.
• 10:08
  SPEAKER_01: So we always recommend getting your arms around like the big picture and then making the decision on as to how to remediate that exposure.
• 10:17
  SPEAKER_00: Got it.
• 10:17
  SPEAKER_00: Wow.
• 10:18
  SPEAKER_00: Okay.
• 10:19
  SPEAKER_00: So we hear a lot of voluntary disclosure agreements as a way to address past exposure.
• 10:24
  SPEAKER_00: When is a VDA a smart move and when might another approach make more sense?
• 10:28
  SPEAKER_01: Yep.
• 10:29
  SPEAKER_01: And that that builds on the last point there in the prior question, right?
• 10:32
  SPEAKER_01: A VDA is is a great strategy, especially when you've got material exposure or exposure that extends well past the state's normal look back period or past their statute of limitations.
• 10:44
  SPEAKER_01: I think you know, understanding your eligibility to participate in a VDA is important.
• 10:48
  SPEAKER_01: Uh, you're often precluded, one, if you've got a registration out there for sales tax already and been missing you know return filing deadlines.
• 10:55
  SPEAKER_01: If you've got you know existing returns and have been uh materially under reporting, uh that could that would preclude you.
• 11:02
  SPEAKER_01: Uh some states will allow you in some cases to take advantage of a BDA, even when you've got an existing registration.
• 11:10
  SPEAKER_01: Um, if you've got notices or audit questionnaires or nexus questionnaires from a state, that can sometimes preclude you from participating and taking advantage of a BDA.
• 11:19
  SPEAKER_01: Um But generally speaking, the rule of thumb is if your materiality or if the the value of your exposure uh exceeds a certain point to where you know the guaranteed waiver of penalty makes makes sense, I would say uh pursuing a BDA is definitely a strong option.
• 11:36
  SPEAKER_01: Um the alternative would be just simply registering and filing going back to your first Nexus trigger date.
• 11:44
  SPEAKER_01: Um and you have to do that technically because when you register, uh you're doing so under penalty of perjury.
• 11:50
  SPEAKER_01: And so prospective registration, as we mentioned in the prior question, is not really a legal option.
• 11:57
  SPEAKER_01: Um and so it's really a matter of once you identify that historical exposure, if it's not that material, registering back to original Nexus trigger day, it's often the right move.
• 12:07
  SPEAKER_01: It's fast, it's it's easy.
• 12:09
  SPEAKER_01: Um, you you get automatic penalty and interest applied.
• 12:13
  SPEAKER_01: Sometimes you can ask for a waiver of penalty.
• 12:16
  SPEAKER_01: Very rarely can you ask for a waiver of interest, but if it exceeds materiality, um, or you've got a really long look back period that would create a ton of um penalties, interest, uh delinquency, uh fees, it makes good sense often to pursue a BDA.
• 12:32
  SPEAKER_00: Got it.
• 12:33
  SPEAKER_00: Okay.
• 12:34
  SPEAKER_00: So here's another one I think catches companies.
• 12:37
  SPEAKER_00: Most of our companies are businesses, so our sales are probably exempt.
• 12:42
  SPEAKER_00: From your perspective, what's missing from that assumption?
• 12:46
  SPEAKER_01: Yeah, I think it's it's a very narrow uh assumption.
• 12:50
  SPEAKER_01: There are some there are a number of states that offer a B2B exemption.
• 12:53
  SPEAKER_01: It's got to be documented supported.
• 12:55
  SPEAKER_01: Um, I think generally expecting that to be the case is not a dominant strategy.
• 13:00
  SPEAKER_01: I think it creates exposure.
• 13:02
  SPEAKER_01: And uh you want to vet that assumption fully and make sure you're documenting and supporting that position correctly because taking that as a blanket sort of approach is just it's it's risky, frankly.
• 13:13
  SPEAKER_00: Got it.
• 13:14
  SPEAKER_00: Okay.
• 13:15
  SPEAKER_00: So with all the sales technology available now, you'd think compliance would be getting easier.
• 13:21
  SPEAKER_00: So what's something automation still can't protect a software company from?
• 13:26
  SPEAKER_01: Yeah, there are a ton of different uh automations out there and sales tech software's out there.
• 13:31
  SPEAKER_01: Uh I'm agnostic to all of them.
• 13:34
  SPEAKER_01: I have to support all of them just because I support clients who use uh a number of them across the spectrum of available options.
• 13:41
  SPEAKER_01: Um so I don't I won't choose a favorite or anything like that.
• 13:45
  SPEAKER_00: You don't have to name names right now.
• 13:47
  SPEAKER_01: But I will say that that automation is only as good as the configuration of the software.
• 13:54
  SPEAKER_01: And so that automation can't protect you from taking a bad tax position.
• 13:58
  SPEAKER_01: And what that really looks like in practical terms is mapping your product to the best fit product tax code or tax category code, or depending on what software you use, there's different nomenclature for those.
• 14:10
  SPEAKER_01: But um, ultimately, the the mapping of your product to their uh category, which then pings off of their maintained matrix to get a tax determination, that at its core is something that their automation is not going to fix for you or identify risk for you.
• 14:27
  SPEAKER_01: And that's where you want to involve a competent third party who deals in this uh daily.
• 14:33
  SPEAKER_01: Um if a product's misclassified, um that that in and of itself, that's the problem.
• 14:38
  SPEAKER_01: Um sometimes integrations can drop transactions or transactions can get held up uh for a number of reasons.
• 14:45
  SPEAKER_01: Uh there's timing that can come into play.
• 14:47
  SPEAKER_01: Sometimes the ERP doesn't talk correctly to the tax software and you know misses out on credit memos that are created manually and don't hit the API call that's made from your ERP to the tax software.
• 15:00
  SPEAKER_01: Uh sometimes the tax software isn't configured to pull from all your different revenue streams.
• 15:05
  SPEAKER_01: If they don't flow through or they're they have uh different invoicing platforms, you often see the connectors are only picking from one of those.
• 15:12
  SPEAKER_01: And so making sure you've got a good team helping with that configuration and integration is is critical.
• 15:19
  SPEAKER_00: Okay, so the best way to make your data has to be good and your configuration has to be good to make sure your automation is like spot on.
• 15:27
  SPEAKER_01: That's right.
• 15:29
  SPEAKER_01: Clean data moving from invoicing or ERP to software and then the decisions to map those those data points in between.
• 15:37
  SPEAKER_01: That's what it comes down to.
• 15:39
  SPEAKER_00: Okay.
• 15:39
  SPEAKER_00: All right, last one.
• 15:41
  SPEAKER_00: Let's do it.
• 15:42
  SPEAKER_00: If you could sit down with a software company before it expands into five or ten states, what would you want them to get right before that growth even happens?
• 15:53
  SPEAKER_01: Great question.
• 15:54
  SPEAKER_01: Um, I think there's a lot of right answers here, but I think uh if we build on the last answer, it's all about data and mapping your products correctly and making sure it's all flowing into the sales tax uh determination software ultimately.
• 16:10
  SPEAKER_01: And so I really would suggest that they just establish a scalable foundation as these new states are coming online.
• 16:16
  SPEAKER_01: Uh having that clean product mapping is paramount.
• 16:19
  SPEAKER_01: Um, making sure you're documenting the tax classifications where needed.
• 16:23
  SPEAKER_01: If you need a third party to create a sort of taxability memo that sort of documents some of those decisions that are being made, um, that's really helpful.
• 16:31
  SPEAKER_01: Uh on the data front, scrubbing that, making sure you've got reliable customer location data.
• 16:36
  SPEAKER_01: Um, we often see software companies have issues with sourcing because some transactions are sourced to the bill to, some are sourced to the ship to, uh, and then figuring out which is the correct jurisdiction to evaluate the taxability for that product is it comes into play.
• 16:55
  SPEAKER_01: Um, I think contracts and invoices as part of your foundation should address tax to an extent.
• 17:02
  SPEAKER_01: I think a tax clause makes a lot of sense in many cases.
• 17:06
  SPEAKER_01: I think working with an advisor to make sure your billing is the most tax efficient manner.
• 17:13
  SPEAKER_01: And sometimes that means um taking the bundle and breaking it into its component pieces or grouping things with like taxability.
• 17:21
  SPEAKER_01: Uh, there are a number of different strategies there.
• 17:24
  SPEAKER_01: And then understanding your customer profile and making folks within the org aware who are working on those customer relationships, um, making sure they understand, you know, when when a customer says, hey, we're exempt, what does that really mean?
• 17:39
  SPEAKER_01: And what are you collecting to document that?
• 17:42
  SPEAKER_01: Are you collecting a resale certificate?
• 17:43
  SPEAKER_01: Are you collecting a multiple points of use exemption certificate?
• 17:47
  SPEAKER_01: Is it exempt based on uh 501c3?
• 17:51
  SPEAKER_01: Is it a B2B exemption that should be applied that might reduce it from 6% to 1% in Connecticut?
• 17:58
  SPEAKER_01: Um and you know, understanding Nexus ultimately, because when you go and register in the States, if you're purely a remote seller, your registration and the return mechanics look a little bit different than if you actually have physical presence.
• 18:13
  SPEAKER_01: So that's a Nexus question, really.
• 18:15
  SPEAKER_01: And but it will uh change how you need to set up your compliance effort.
• 18:21
  SPEAKER_01: Um and understanding what your your growth is gonna look like and your uh the number of states you're gonna move into will also help inform you and a third party if they're helping you, a consultant, um, with picking the best sales tax software if you don't have one yet.
• 18:39
  SPEAKER_00: Okay.
• 18:39
  SPEAKER_00: Well, thank you, Adrian, for all of your insights on sales tax challenges with SaaS and software companies.
• 18:46
  SPEAKER_00: I'm sure a lot of people are like, um, let me go dive into my records a little bit more.
• 18:52
  SPEAKER_00: Um hopefully they don't find too many horrible things.
• 18:55
  SPEAKER_00: But if they do, they know where to find everybody.
• 18:57
  SPEAKER_00: So that's right.
• 18:58
  SPEAKER_00: That's right.
• 18:59
  SPEAKER_01: We do this all day.
• 19:00
  SPEAKER_00: I know all day, and that will get you all set up.
• 19:04
  SPEAKER_00: So thank you so much, and I hope to see you back on the show again.
• 19:07
  SPEAKER_01: Thank you, Sardet.
• 19:08
  SPEAKER_01: I appreciate it.
• 19:09
  SPEAKER_00: No problem.
• 19:11
  SPEAKER_00: The big takeaway from today's conversation is that sales tax can quickly become more complicated as a software company grows.
• 19:18
  SPEAKER_00: Understanding where you have obligations, identifying potential exposure early, and putting the right processes in place can make a big difference as your business expands.
• 19:28
  SPEAKER_00: Thanks for tuning in to Beyond the Ledger.
• 19:30
  SPEAKER_00: For more insights and expert perspectives, visit btcpa.net and explore our latest resources.
• 19:36
  SPEAKER_00: And don't forget to like, follow, share, and subscribe.
• 19:39
  SPEAKER_00: Until next time, I'm Sardet Layfield, and we'll see you for the next conversation.