We face many interesting sales tax issues in California, and in Silicon Valley specifically related to technology companies. We often deal with things that are either difficult to tax, or at the very least difficult to categorize. An example is the cloud computing platform, also known as Software-as-a-Service, or SaaS.
An Overview of SaaS Companies
SaaS, or cloud computing, is defined by Wikipedia as “A software licensing and delivery model in which software is licensed on a subscription basis and is centrally hosted. It is sometimes referred to as "on-demand software”.” SaaS is typically accessed by users via a web browser. Most likely, you’ve used SaaS without ever realizing it. Cloud-based services are those you stream directly from the Internet, and they can come in different forms, but with similar characteristics. The National Institute of Standards and Technology (“NIST”), a division of the Department of Commerce, defines cloud computing and lists five essential characteristics of a SaaS platform, including:
- On-demand self-service
- broad network access
- resource pooling
- rapid elasticity, and
- measured service
State Sales Tax Issues for SaaS Companies in California
While California is often singled out as a difficult state in which to do business (and there is plenty of evidence to support that argument), the State’s treatment of SaaS is relatively straightforward, although the state does lack statutory support for its position at this time. But, let’s start where we often do in state tax (and multi-state tax) issues, with nexus.
- Nexus: When a company is engaged in multi-state activities, it is key to first determine where the company has created taxable presence, or nexus. A variety of things typically create nexus for SaaS companies. We find that SaaS companies are often growing quickly and sending a traveling salesforce (either their own employees or third party contractors) to customer locations, which can create nexus. In addition, SaaS companies tend to either rent server space at locations across the country, or have their own servers housed at various locations. To the extent that a business is headquartered in California, it definitely has nexus within the state. If the company is domiciled outside of California, but engages in sales activities, has an office, or has a server or other inventory within the state, nexus has likely been created.
- Taxability Part of the challenge for SaaS companies is in the very definition of the product or service itself. Its very monikers, “Software as a Service,” or “cloud computing” may cause confusion for state agencies. Do SaaS companies sell products (software) or services? If the product can be accessed in the cloud, is it a tangible good (like canned software) that is often subject to sales tax? Or is SaaS a taxable service? Historically, state tax laws have dealt with either tangible personal property (generally taxable, unless there is an exemption), or services (taxable if specifically enumerated). But SaaS doesn’t clearly fall into either of those categories. Is it an intangible? In many states, software downloaded electronically is considered exempt. That’s true in California. California has not specifically addressed cloud computing by statute or regulation. However, California does not impose tax on the electronic delivery of prewritten computer software. [ See California Tax Publication 109 ] In some states, SaaS is taxable as part of information and data processing services. But those are also not taxable in California. [Cal. Code Regs. tit. 18, §1502(c).] As such, SaaS is deemed to be not taxable in California.
Yet, it’s important to note that in many other states SaaS is considered to be taxable – either because it is deemed to be software and is taxable no matter how it’s delivered or because it is defined as taxable by statute. Some states tax SaaS as an enumerated service. We often assist multi-state clients headquartered in California, where SaaS is deemed non-taxable, only to find that they have also incorrectly assumed that it is not taxable in other states. (Some others that tax SaaS currently include AZ, NY, TX, and WA, to name a few.)
When do you need help?
We find that we can provide value for clients in assisting them to determine where they have nexus. Then, we perform a detailed review of the standard licensing agreements or service agreements they have with their customers (sometimes the way the product is described in the contracts leads us to evidence of taxability or not), and determine which states tax the SaaS platform. To add to the challenge, some states have not yet made a definite determination in their taxability of this revenue stream, leaving some uncertainty and room for interpretation. As such, we work with our clients to determine a practical approach in reaching a conclusion and keeping up with any changes. Finally, we assist in the determination of sourcing their revenues to the proper state and assisting with retroactive remediation (like Voluntary Disclosure Agreements) and a solid plan going forward as they expan
Other recent “California (CA)” posts by Monika Miles, CPA:
- CA Board of Equalization: Changes to Sales-Use Tax Administration
- SaaS Taxation in California - An Overview
- CA District Taxes – Are You Calculating the Full Rate?
- Business Donations in CA: No Free Lunch When It Comes to Use Tax
- When Is Food Taxable in California?