What is a Sales Tax Nexus and as a SaaS founder why should you care?

published on 21 March 2023

As a business expands, it ventures from its local territory to hitherto unknown ones. While the roads to those markets are easy as long as you stay national, the real trouble comes your way when you plan on expanding your business globally.

All countries have their own statutory and regulatory requirements that you need to adhere to before you can start doing business there. And you would assume that while there might be a little change in requirements from country to country, in most cases they are quite stable. And in some cases, you would be right. In most others, you will find the task much more daunting.

USA is one of the biggest markets in the world. A promise of freedom and free world economy, USA has always been the champion of capitalists all across the world and justifiably so – they have the most forward thinking citizens and they have the numbers to truly justify “economies of  scale”. They also have the infrastructure and technology available to be able to open a business quickly and start reaping in those profits. However, before you start dreaming about those profits, the process of registering, preparing and remitting sales taxes in the USA, which is a salient part of the process of doing business in any country, really wakes you up.

Part of the reason why the USA has always been a capitalist’s darling is because they are agile enough to change their policies quickly to stay up to date with the latest way of doing business. And while that has its advantages, they also put a SaaS founder in a tricky situation having to wade their way through the myriad, constantly evolving accounting and legal systems. 

The most volatile (and confusing) part of all these regulations is Sales Tax - this is what you are supposed to charge a customer for the services that you are rendering to get the product to them and in turn pay the local government for safeguarding your interests as you go about your business. 

There are, mainly, 3 stages of any Sales Tax cycle - 

  1. Collection from end customers.
  2. Preparing your tax filing that includes reconciliation according to accounting standards.
  3. Remitting (or tax filing) those taxes to the local government as per pre-defined rules.

So, in this article we’ll be discussing:

  1. A brief history of Sales Tax
  2. What are the current Nexuses and thresholds
  3. Why you should care about Sales Tax, and
  4. What you can do about them
Sales Tax
Sales Tax

Image Source

Brief History

Up until 1992, the local state governments in the USA were barred from asking retailers to pay sales taxes unless they were physically located in the state. This was an outcome of a Supreme Court ruling – Quill Corp. vs North Dakota. But as computers really took over the world and the age of the internet started in the mid to late 90’s, most retailers and sellers did not need to be physically located in a particular state to generate sales there – all they needed to do was ship a CD or later, just share a download link. So, in 2018, the Supreme Court when ruling on Wayfair vs South Dakota, held that states may charge tax on purchases made form out-of-state sellers even if the seller does not have a physical presence in the taxing state. 

South Dakota, to justify pursuing this path of legal recourse, cited the following issues to the existing laws (pre-2018):

  1. Referring to a study from 2012 conducted by the National Conference of State Legislatures in conjunction with the University of Tennessee, the state pointed out that states lost up to a tune of $23 billion in revenues from collecting sales taxes from out of state merchants and vendors. These losses were projected to only get worse with the steady increase in online sales.
  2. The state contested the “physical presence” aspect of the Quill Corp. vs North Dakota ruling as well. The state pointed out that the prevalence of the Internet makes a state's economic nexus much broader than it was in 1992. And the state argued that while there may have been a burden on out-of- state vendors to comply with these rules, they are no longer a burden for them now.

Taking cognizance of the fact that these new tax rules might actually hamper interstate commerce, the individual states have started implementing thresholds based on the sales numbers and invoices generated. 31 different states have now implemented these new laws requiring taxation on SaaS products, as of Jan 2019, and most of these states follow the South Dakota threshold of 200 transactions or over $10,000 in revenue.

A year on from the ruling, almost all the states have modified their laws to include out of state taxes; but, in some states, even after the updates, the laws do not include any specific criteria that triggers when such taxes can be collected. Small and medium enterprises might think about auditing their sales for each state but the cost-benefit of doing that exercise may outweigh the actual amount that is due to the local government which might prompt them to forgo the process altogether. Similarly, with regards to the local governments, they might think about prosecuting these smaller enterprises but then again, the cost involved for a long drawn legal process, does it really make any sense? Whatever the next course of action, there are rumblings of a large number of potential lawsuits on the back of these tax laws in the next couple of years. The prudent thing to do right now, would be to get your tax affairs in order to get compliant as early as possible.

What is a Tax Nexus?

Nexus in layman’s terms alludes to “connection” – a proverbial thread to a specific state which, if you connect to, are liable to pay taxes to the authorities. 

In simple English, the local govt. will force you to incorporate your company in the country/region if you have crossed the Sales-Tax amount threshold. And start paying local taxes. If you don’t, then you won’t be allowed to sell your SaaS in that region and/or have to pay a hefty penalty

Different states have different criterias that establish this connection or “nexus” but they have a common structure. There are two ways you could hit Nexus:

  1. Physical Presence: If you have any physical presence in a state where you are generating sales, you have to collect and remit taxes in that state. This supersedes any other criteria or regulations and has been in existence even before the Wayfair vs South Dakota ruling of 2018. Physical presence can allude to office space, employees, contractors etc.
  2. Economic Nexus: This is of particular interest for SaaS companies – a liability to collect and remit sales tax even if you are not physically present in a state. This where the most amount of complexity comes in – different states have different thresholds which indicate whether you have hit the Nexus. A table showing examples of such states and the inherent complexities is shown below:
State-wise thresholds (Download the entire table here)
State-wise thresholds (Download the entire table here)

So why should you care?

As a SaaS business, the founder and most of the team are mainly focused on the product and customers; with good reason. The priority is to ensure that the product is up to standards with regards to adding value or solving a problem for the customers and that they have the best possible experience from landing page to checkout and a lot more steps before and after those stages.

Most of the time, founders either outsource their accounting, bookkeeping and taxation to a third party vendor or contractor and lose sight of what is happening on those fronts. While it’s alright to outsource, how and who to outsource the job to is paramount to your business goals. In the next section of this document, we take a look at why you should care about taxes and why you should choose Stykite as our partner to accelerate growth overseas.

Here are some of the reasons why you should care about taxes:

  1. They affect your growth rate – As you start hitting the nexus limit within or outside the USA, you’d have to move fast to be tax compliant in those regions. And if you’re not prepared or keeping an eye, this can be a setback that will take weeks or months away
  2. They impact your bottom line – You do all your marketing, advertising and other customer acquisition activities to generate sales for your business. But what is left as profit at the end of the day is completely based on the efforts to take to manage your costs of which taxes are a very important chunk, if not the most
  3. Prepare for a rainy day – As the threat or the perception of an impending recession looms, customers are buying less. This means that the only way you can keep yourself afloat while your sales plateau is through controls in your costs
  4. Legal compliance – You need to be sure that you always comply with the legal side of the business, lest you get damaged by penalties or even stronger legal action
  5. Avoiding liabilities – If you fail to collect or remit taxes, you might be liable to not only penalties but even interest on what you owe 
  6. Perception & Image – No customer wants to do business with someone who has the government hanging on to their coat tails or has a perception of being a law breaker

As a SaaS founder what are your current options?

As a founder/team for a SaaS company you are left with the following options:

  1. Set Up a Tax (and Legal) team - Set up a team within your current business that deals with taxation laws, have a background in accounting and also have some form of legal knowledge who can keep up with the ever changing dynamics of the various nexuses.
  2. Use a Tax Consultant - Instead of setting up a tax team, you could choose to outsource your tax handling to a contractor/consultant. This is what most SaaS founders chose to do. These consultants have fixed rates that are generally state specific and would take care of all your tax preparation and remitting requirements. They are generally quite expensive and when dealing with exceptions (like back taxes, dealing with penalties etc.) can run a bill that might very well run into thousands of Dollars every month. You will also find that most, if not all, of these Consultants will also suggest that you use one of the popular tax softwares that we discuss in the next point.
  3. Use an Automated Tax Software (+ Consultant) - This is another very popular option for small to medium businesses. If you are able to get your registrations done and invoice your customers properly, an Accounting software in conjunction with a Tax software can ease your pain quite a bit. Products such as TaxJar have the functionalities to give you real time updates on where you’re hitting your nexus and what you owe to the local governments. They also have the ability to prepare a report(s) that you would need to prepare your tax filing and in some cases, even help you file those taxes DIY. This option is almost always a fallacy, as you will find most SaaS businesses still have a Tax Consultant on standby who charges a hefty retainer to deal with “exceptions” and refunds.
  4. Use a reseller/marketplace facilitator - The last option, but in all probability, the best option out of all of these is to partner with a reseller or marketplace facilitator like Paddle or Stykite. This option is fairly new and the adoption of this as a viable option for SaaS businesses is on the rise. In the following section we will explore why that is.
Sales Tax handling options
Sales Tax handling options

How does Stykite help?

Stykite is perfectly poised to help your SaaS business in the following ways:

  1. No Tax Team: Using a product like Stykite completely eliminates your need to set up new teams to handle taxes. The need to stay on top of the ever changing tax laws is completely mitigated when partnering with Stykite
  2. No Risk: When you partner with Stykite, we are liable for all your transactions with your customer. There is no direct association for the sales you make to your end customers. Yes, you still need to develop the market yourself - but all the downstream activities post a customer conversion (except distribution of the actual product), and all the legalities associated with them, falls into the purview of the reseller. Stykite will be liable to bill, collect, prepare and remit taxes for all the sales that you generate in that geography
  3. Protection against fraudulent transactions: As a SaaS founder, one of the main pain points that you have little to no control over are fraudulent transactions - this could be anything from customer verification to dealing with credits. When using Stykite, you are protected against all of these by virtue of our relationship - we will be responsible for vetting transactions and ensuring that your sales are not compromised by frauds
  4. Zero exposure to transaction failures: This ties in with the previous point - since Stykite will be dealing with the actual transaction, we will be responsible for failures (and re-attempts at collection), if required
  5. Cost Effective: Sure, you could use a Tax software to file your taxes and a Consultant on retainer to handle exceptions. But are you really optimizing your profits efficiently when operating like this? Couldn’t you just eliminate this overhead by paying a small commission for an actual sale? Stykite does not charge any retainer fee or any other overhead - you only pay if you have an actual sale
  6. Speed to Market: We reduce the time to launch into a new country by 99%. Compared to the usual process of forming, registering and setting up of new entities and hiring the requisite resources, under the perfect circumstances, we can get you up and running in 30 minutes flat!
  7. Plug and Play for any Geography: Whether you want to venture into a new state in USA or to another country altogether, we have the product to help you achieve that without any of the hassles generally typical of such expansive moves
  8. SaaS centric: Being a SaaS business ourselves, we understand your business and customers better than any of our other competitors. We have designed and built our product to suit a SaaS business's unique needs.

Download the USA & Rest of World Tax Nexus limit table here.

Do let us know what you think at talktous@stykite.com

Or, come talk to us and book a meeting here.