This blog was last updated on September 7, 2023
In addition to selling automated solutions, software-as-a-service (SaaS) companies often provide a variety of related services, including configuration, implementation, training, testing, bug fixes, technical support, and software enhancements. Each of these services could have sales tax consequences different from those applicable to the underlying software. Even more challenging, the rules can sometimes vary based on the context surrounding how that ancillary service is provided. So how can SaaS organizations keep everything straight? What must remain top of mind when it comes to ensuring the right sales tax is applied to products – and services?
We have highlighted three key things for software companies to keep in mind when it comes to evaluating the accuracy of their sales tax compliance.
Consulting
Consulting services, when not associated with the sale or license of software, are frequently considered a professional service. As such, sales tax would only apply in the handful of states that tax services broadly or tax consulting specifically.
However, when consulting is sold by a SaaS provider, it’s possible for the tax rules to change. For example, if a software provider licenses its SaaS solution but also sells implementation services, the tax treatment of the implementation could, in some states, follow the tax treatment of the software. In this context, it is important to know whether the consulting services are a mandatory or a fully optional element of the sale.
In many states, mandatory software consulting would be taxed in the exact same way as the underlying software based on the theory that buying the consulting service is “necessary to complete the sale” of the software. Some states would extend that same theory to “optional” consulting while others may allow truly optional software consulting to be non-taxable. Whatever you do, do not think that a service will be considered “optional” merely because it has its own line item on the invoice. For a service to be considered optional, the buyer must truly be able to acquire and use the software without it.
Training
In today’s world, software training can be provided in the traditional style (in person or by teleconference) but also can be pre-recorded and downloaded, offered through an automated tutorial, or even live streamed. Like consulting, stand-alone training would often be considered non-taxable as a professional service. However, the same mandatory/optional/necessary to complete the sale distinctions exist here and will frequently impact taxability when training services are sold alongside SaaS software.
At the same time, SaaS providers also must consider the facts and circumstances surrounding their training offerings. In most cases, any tangible training materials provided with the training may be considered de-minimus or otherwise not the “true object” of the sale. Accordingly, they mostly do not impact taxability. However, how the training is offered and what is provided under the “training” umbrella could change how sales tax applies.
Take for example this rule in Washington. Live online classes are not subject to sales tax but only if they allow for real-time participation and interaction between the instructor and the students. However, to qualify, the interaction must be a part of the live class and not just a separate ability to ask questions through a chat room or digital help desk. Classes, including prerecorded videos, which do not allow for real-time interaction between the presenter and participants, are fully taxable.
Support services
As was the case with consulting and training, stand-alone technical support may be exempt as a professional service, but SaaS companies must continue to understand that context is king. Just as above, the true tax answer can vary based upon whether the support service is a mandatory or optional component to the license of the software. Complexity also arises when support is provided as part of a software maintenance contract, which could include the right to receive software upgrades and updates.
Several states have enacted rules recognizing that software maintenance contracts are, essentially, a bundled transaction that include the right to receive non-taxable support services along with taxable software. Those states then divide the sales price and hold that only X% of the sale price is subject to tax. For some states that split is 50/50, for others it’s 80/20 and for one or two others it’s 60/40.
Unfortunately, sales tax professionals do not run the world and some companies may opt, for sales and marketing purposes, to “bundle” the cost of their ancillary services into the cost of the software and offer the whole thing for a single combined price. When a software company makes that choice, it may lose its ability to accurately tax each component of the bundle. When a bundle contains taxable and non-taxable components, and all those components are material to the sale (software, training, support services, implementation/consulting), then the most compliant course may be to apply tax in every state where at least one element of the bundle is taxable. In the case of SaaS software, that frequently means a provider will be charging tax on the full price in every state where SaaS software is taxable, even if the other components are properly non-taxable when separately billed.
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