The relationship between software and sales tax is complicated. Simply put: Growth breeds growth — and risk.

Business growth often results in the growth of sales tax obligations for you and other high-growth software companies. It’s a parallel relationship riddled with hidden risk. After all, if you’re so focused on growth that you don’t see new sales tax obligations sneaking up on you, it won’t be long before you’re behind on compliance.

Sales Tax Compliance for Software Companies

So where does this risk originate? And how are software companies looking to manage it? Avalara surveyed 50 software companies of various sizes to find out. Review the major findings of the 2017 Avalara Sales Tax Survey for Software Companies below.

The origins of sales tax risk for today’s software companies

Sales tax risk, in part, is a byproduct of the software industry’s agility and speed. The faster you hire new staff, open new offices, or release new products, the faster your sales tax obligations add up. In fact, the Avalara survey found that software companies trigger an average of nine new sales tax obligations every year.

How? By engaging in nexus-triggering events, i.e., business activities that create nexus, the obligation to collect and file sales and use tax in a state based on your activities within that state.

The chart below identifies and ranks the nine ways software companies, through rapid growth, tend to trigger new sales tax responsibilities.

Common sales tax triggers for software companiesMany of these activities can be easy to overlook as nexus triggers. Take the most common: hiring new staff. What’s that got to do with software taxation? Well, if you hire someone who works remotely from another state, that state may consider the employee a physical extension of your business. Thus, you have a physical presence in the state and the responsibility to collect sales tax there, according to physical presence nexus.

Tricky, right? Even more so when you consider that:

  • Software taxability rules are changing. A certain activity may not trigger nexus for you in a particular state one month, but it could the next.
  • Different states, different rules. Regulations on software taxability are like fingerprints —  unique in every state. That goes both for how you establish nexus and for how your products are taxed.
  • Software companies rely heavily on manual processes to stay current. As the chart below shows, the majority of survey respondents rely on manual research, in-house staff, or third parties to keep them up to speed on sales tax policy, which must then be reflected in their ERPs and ecommerce platforms for accurate tax calculations on all transactions.
    software company compliance pie chart

With the fast pace of change in both the software industry and sales tax policy, it’s highly probable for your company to outgrow your current sales tax processes — potentially without you realizing it. The risk there is being out of compliance, which can lead to sales tax audits and even to trouble with valuation and funding.

More efficient sales tax management is on the minds of software executives

One way to stay on top of sales tax compliance is through accounting or tax software. Survey respondents expressed a strong interest in software that can increase efficiency and reduce risk. Here’s how they ranked four potential benefits of such software, from most to least important:

  1. Increase overall company efficiency by reducing the resources spent on tax compliance
  2. Reduce tax risk by ensuring accurate sales and use tax determinations
  3. Seamlessly integrate with existing accounting systems and tools
  4. Improve company efficiency by reducing the time it takes to close books

According to the survey, CFOs — the segment most likely to take responsibility for decisions related to tax compliance — in particular gravitated toward increasing company efficiency, with 7 out of 10 CFOs naming it as a top priority.

The good news for software CFOs, and many others, is that tax software with such capabilities already exists. When you adopt tax automation software, you help eliminate errors that stem from manual processes. In return you gain efficiency and accuracy, with a tax compliance solution that’s a seamless part of your overall business ecosystem and growth strategy.

The majority of survey respondents agreed that having such a solution in place, one that instantly applies the right sales tax rates and rules to digital goods and services, is a priority for their business. Also high on the list: avoiding audit trouble related to remote and contract staff; developing the right sales tax strategy for a successful business plan; and instantly recognizing changing tax obligations based on how products and services are sold and where customers are located.

The Software Executive’s Guide to Sales Tax, a new series from Avalara, takes you through developing and operationalizing a future-proof sales tax strategy to support your growth. Download Part 2: Operationalizing Your Sales tax Strategy now.

About the survey
The 2017 Avalara Sales Tax Survey for Software Companies includes 50 software companies in the U.S. and Canada with 20 to 999 employees. Respondents occupy such roles as manager, CFO, accountant, vice president, and others.

Sales Tax Compliance for Software Companies