Presented by CereTax
When you’re an early-stage startup, your top priorities are conserving capital, and keeping your pricing competitive. You’re trying to offer a cost-effective solution to your customers. Determining whether your digital service or solution owes sales taxes on top of that can be a complex undertaking, especially in the SaaS space. Since you are probably focused on creating revenue and generating sales opportunities, sales tax probably isn’t high on your list of priorities.
The consequences arrive in the shape of an unfunded liability — a liability that appears on the books that you had not anticipated, so you don’t have funding set aside for it.
“If you’re selling software, SaaS products, communications services, IoT, M2M, medical devices — there are so many industries that have very unique taxation rules,” says Brent Reeves, CRO of CereTax. “You really need to pay attention. These unfunded liabilities pop up usually because an organization isn’t aware that a sales tax even applies to their type of business.”
Unfunded liabilities are not only budget killers, they also can directly impact customers and customer relationships, while causing a lot of concern among shareholders or investors.
Why unfunded liabilities are dangerous
“Unfunded sales tax liabilities are hazardous to the health of a business for a variety of reasons,” Reeves says. For one, once your liability is identified, it doesn’t go away. When the bill comes due it must be paid — even if you sell your company. You remain responsible for those sales tax liabilities going back as far as the impositions are applicable. Reeves also notes: “Most people do not realize that some of these impositions can attach personally to directors and C-level employees.”
These liabilities are also not always easy to identify. Even with a sales tax strategy in place, state and federal laws and regulations change frequently. You can also have internal tax teams or tax consultants that improperly identify your tax responsibility, and suddenly, you have unforeseen tax liabilities on your hands. Depending on the product or service, these liabilities can range from 5% to 35% of past sales dollars that you should have been collecting taxes and fees on.
It happens with startling regularity to SaaS providers that don’t realize part of their services fall under communications laws, such as software products that enable a certain amount of voice capabilities. Even if the service itself isn’t intended to be a communications service, such as software that links to a communications platform, an audit might still deem your business as a communications service. That means you could suddenly be liable for Federal Universal Service Fund charges, local, and even state service fund charges and a myriad of other communications taxes, which could add up to 35%.
“There are a lot of products and services that have been created, over the last decade, that use internal communications and connectivity to monitor and deliver many kinds of data to users — and that can suddenly, and unexpectedly, tip that product or service over into the communications world, for tax purposes,” Reeves says. “We see it a lot more than you would think, from automated systems to intelligent assistants, chatbots and so on.”
The consequences of unfunded liabilities
Business valuations are tied to margins and top-line revenue. If you haven’t been collecting the appropriate taxes, they will go straight into an expense category and thus can dramatically affect your margins.
When a sales tax issue is identified, investors will look to see how the company will manage this sudden change in expense to minimize any damage to the valuation. They will want to see how both the business and customers will respond. Will this create new customer churn? What mitigation strategies will be needed and how will they measure the number of customers that will be at risk, or at the very least, disappointed? They will worry about whether it’s a short- or long-term impact to the gross margin, and whether the company will be able to raise prices enough to compensate or adjust billing to recoup this tax.
An often unexpected consequence of these liabilities is the way they can directly and negatively impact the customer relationship. When a customer is suddenly hit with a brand-new sales tax charge, this change can cause a lot of frustration on their end. The last thing any business wants is to give a reason for their clients to look at alternatives.
How to become compliant and eliminate liability
It takes a big shift in internal policy and procedures to address existing unfunded sales tax liability, and to prevent future issues. You first need to identify what your liability entails, how large the problem is, and how to move forward. “If you suspect you are out of compliance, I recommend sitting down with a sales tax professional or a consultant to help navigate through it, rather than going it alone,” says Reeves.
A tax expert can give you the lay of the land, as well as develop a plan for going forward with a new tax policy that correctly addresses the tax laws in the areas you sell your products or services. Most importantly, start collecting and remitting going forward, while simultaneously developing a plan to mitigate past exposure and prepare voluntary disclosures where appropriate. “I highly recommend using the services of a professional who specializes in your product or service offerings, not just an accounting firm or law firm.”
Once you’ve determined your path, implementing an intelligent, automated solution means you’ll have the data you need to stay on top of rule and rate changes, while adjusting your taxes as necessary — which will ensure audits go smoothly.
CereTax built its intelligent tax platform using the most current tax data and inputs to analyze every facet of a transaction to make precise tax decisions — from the exact nature of the provider to the consumer, as well as the location and purpose of the transaction. All that data is available at a user’s fingertips, letting them drill down to see how each individual item is taxed, along with explanations for those decisions. Statute and citation references are available at the transaction level through the UI.
APIs integrate CereTax with all point-of-sale, billing platforms, ERPs and shopping cart systems. The solution is built to automatically scale when businesses move to new markets, add new systems or products, or expand their tax footprint.
“Laws and tax policies change, so the number-one piece of advice I could give anyone is to review your situation regularly with a professional,” Reeves says. “And then utilize an automation platform that can adapt to the changing needs of your business.”
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