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Why Software Industry Finance Leaders Automate Sales Tax Compliance

Avalara

Digital domination drives today’s economy, according to Accenture, and process automation is setting new standards in how we benchmark performance. Most companies use this technology freely through their organization. Software and technology are no exception. But for these businesses, which are modeled on scale and efficiency, the stakes are higher. Today’s tech companies are increasingly being pressed to grow their core business or reinvent themselves before they are disrupted by competitors.[1]

In a recent ZDnet interview, several top technology c-suite leaders admitted that having internal processes automated has helped them shift their focus from operations to innovation. As Oracle’s CFO put it, digital-first priorities and processes allows finance leaders to shift their thinking from looking backward to looking forward to the future. And that future includes using SaaS technology to manage tax compliance.

Why great software and technology companies automate sales tax

Sales and use tax management is virtually impossible in the technology industry without automation. The researching, calculating, filing, and reporting required for compliance is not only time-consuming, it’s costly and highly prone to error — a terrible trifecta that makes CFOs and controllers cringe. The average cost of managing transactional tax compliance is more than $60,000 annually for small businesses and nearly $400,000 for large organizations.[2]

Automation is the number one tax compliance strategy employed by leading companies compared with their trailing peers. Aberdeen Research found that these market leaders are three times more likely to automate sales tax. Yet only half of Fortune 1000 companies have an automated tax solution.

So why the adoption gap? “In the very early stages, companies often have an outsourced bookkeeping function,” explains Lisa Serwin, CFO of VentureBeat. “It’s not until later in their growth that they get an internal finance department, let alone a full-time CFO. Tax is often an afterthought.”

But it shouldn’t be, says Serwin. “Using tax automation to ensure compliance is one of the best things you can do for your company. If there is an audit or a financing event, exit or IPO, being clean and consistent and having an auditable record is of the utmost importance.”

Tech industry may have it the hardest

Software and technology companies have unique challenges when it comes to managing sales tax. The taxability definitions and rules for software vary widely across jurisdictions and delivery mechanism. Today, software is taxed in numerous different ways based on multiple distinct categories.

 

In the software and technology industry, what is taxed versus what is not taxed can be counterintuitive, and varies from state to state and category.

  • Web-based software is taxed in 17 states, partially taxed in 2 states and taxed only if the provider has a server in that state in 8 states
  • In Colorado, taxability varies by county
  • Digital movies are tax-exempt in 23 states and charged at 1% in Connecticut
  • Digital photography is tax-exempt in 23 states
  • Digital games are taxed in 26 states
  • Software training is taxed in 10 states
  • Installation of hardware is taxed in 21 states
  • Software maintenance contracts are taxable in 24 states and partially taxed in 1 state

 

New delivery models mean more sales tax challenges

Gone are the days when software meant a disk sold in a store at a single tax rate that the dealer managed. Rather, software represents constantly innovating new methods of digital delivery like SaaS. And new offerings, like a mix of software, services, and hardware. Layered on top of the checkerboard of rates and rules in the U.S., these trends make taxability in the tech industry highly complex.

For example, in some states, sales tax applies to the gross receipts from the sale of all service or maintenance contracts covering computer software. When computer software and non-taxable products (i.e., support services) are bundled together and not itemized on invoices, the entire amount may be subject to tax. Software support services and website development services are often taxed differently.

The prevalence of subscription billing and SaaS delivery models also create a perfect storm. Selling via subscription service is great for generating recurring revenue, but by definition creates a new invoice, and therefore opportunity for errors on the books, each month. And the borderless nature of SaaS delivery creates a tangle of taxability depending on sourcing rules in the jurisdictions of both the software vendor and the customer.

Outgrowing manual tax management

As software businesses grow, they are more likely to trigger nexus, or an obligation to collect and remit sales tax in new states. More states are expanding the definition of nexus to include activities such as employing remote staff and attending tradeshows. And the borderless nature of software delivery means a tiny startup can have customers in every state. All this pushes the firm out of compliance as existing processes for managing tax are no longer adequate.

“We’re growing like crazy,” says Linda Tom, accounting manager at Isilon Systems, a provider of clustered storage systems and software for file-based data. As Tom explains, Isilon Systems found itself with obligations in so many states that it could no longer manage sales tax with the processes it had in place. “It got beyond the point of being able to handle it manually. We couldn’t keep up.”

Isilon Systems worked with Avalara to automate sales tax calculation and filing, and now Tom’s team can devote the time they previously spent managing tax to activities that add value to the business units.

Non-compliance can affect valuation

Most promising technology companies will at some point need funding from venture capital or IPOs. Both events drive the need for better due diligence and tax management, as evidenced by Synergy Services. An audit revealed that the IT support and services company had miscalculated sales tax on more than $2 million in revenue. At the time, the company was operating in eight states and its salesforce was manually calculating tax rates for customer invoices.

Synergy implemented Avalara’s AvaTax sales tax automation software. The next year’s audit showed zero miscalculations or errors. And every audit since has been clean. “We didn’t have tax issues anymore. It’s as simple as that,” states Ben Moyer, CEO and owner. MyTech Partners acquired Synergy Services in 2013.

A best practice in scale and efficiency

Happily, finance leaders at software and technology companies have been quick to adopt tax automation. They’re comfortable with the cloud, see the benefits of technology over manual processes, and have high standards for scalability and performance in the solutions they use since these are often the same principles upon which their products are based.

“We run on a cloud-based environment and so do the users of our products,” says Charles Best, CFO of BlackLine Systems, a financial process and controls SaaS company. “We’re growing rapidly and need more robust sales and use tax capabilities. Avalara has perfected this niche and they’ve done it very well. There’s no reason to do it in any other application.”

Automating sales and use tax is a huge time and money saver for businesses. Forrester Research ran an economic impact study on several ERP customers and found that these companies had the equivalent of two accountants spending 70% of their time manually invoicing customers and determining sales taxes. After automating this process, these same companies saved the equivalent of 1.4 accountants’ time and expense annually (an average of roughly $385,000 over five years).

TechValidate surveyed companies that use Avalara’s sales tax automation software and found that, on average, these companies reduced the time spent managing sales and use tax by 50% or more. Some AvaTax customers saw even higher results—cutting their time from 20+ hours to less than one hour.

“When we started doing more business in different states, sales tax was getting more complex and taking more time for the team to manage … filing on time, getting the rates right, there was always a problem,” says Ray Duong, Finance Analyst for Argus Software. “We looked at different sales tax solutions and Avalara was the front runner. It’s already integrated with our system, it’s automated, and it’s simple to use. We went live within a week. It used to take hours to do sales tax. Now it’s maybe an hour.”

As with any new technology investment, ease of implementation and scalability are important criteria when evaluating an automation plan. “Whenever we evaluate a new tool, we ask the question, can we afford this today and does it get us where we need to go in three to five years?” says the CFO of a quickly growing Seattle SaaS firm.

Avalara AvaTax has pre-built integrations into more than 580 systems for invoicing, accounting, ERP, POS, and ecommerce. Automating sales tax helps reduce audit risk and is bandwidth- as well as budget-friendly.

Get on board with better compliance outcomes

The payoff of sales tax automation are compelling. Research shows that Avalara AvaTax customers:

  • Cut their monthly returns prep and filing work in half
  • Avoid overpayment 90% more often
  • Pass audits without penalty 50% more often

So it’s not surprising that once businesses decide to automate tax compliance, they never look back. More than 98% of the companies that implement Avalara’s software are still customers Avalara customers today. That’s more than 20,000 companies, including tech leaders like Salesforce, Jive, Marketo, Citrix and 1,400 other firms of all sizes. In the tech industry alone, Avalara made compliant 6.3 million transactions valued at $8.5 billion.

If you aren’t automating sales tax with Avalara like these software and technology leaders, the question now is: what can we do to change that?

[1] Accenture, 2016 Technology Vision Report

[2] Aberdeen Research, The Costs of Compliance: Strategies for Automating Tax Management in the Cloud and Avoiding Hidden Costs

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