Sales tax nexus and software: why traditional rules don’t apply
- Sales and Use Tax
- December 18, 2017 | Kerry Alexander
Understanding nexus is one of the hardest aspects of sales tax management. It can be especially frustrating for software companies because tax laws haven’t adapted to how the industry creates, sells, or delivers products and services to customers.
A survey of all state tax departments in the U.S. published last year by Bloomberg BNA evidenced this complexity in detail, providing explicit data on how each state regulates multistate nexus for both corporate income tax and sales tax. Slogging through the 507-page tome is no small feat (I did it). But it’s nothing compared to the task of extrapolating which rules apply to your business.
To put this daunting prospect into perspective, Avalara and Bloomberg Tax partnered to produce Nexus and Multistate Taxes: A Brave New World for Software Firms. This palatable four-page summary details exactly how multistate nexus impacts software companies and what they need to know — and do — to be compliant with sales and use tax regulations related to nexus.
An abridged history of sales tax nexus
Sales tax nexus, a connection to a state that obligates a seller to collect and remit sales tax to the state, dates back as far as 1939. Over the past eight decades, it’s been the subject of much debate and multiple court cases. The most current legal definition of nexus stems from the 1992 Quill v. North Dakota Supreme Court decision, which stipulates a substantial physical presence caveat for requiring states to collect and remit sales tax on transactions into a state. That mandate is now grossly outdated in the wake of ecommerce. The ability of remote sellers to sidestep sales tax irked brick-and-mortar retailers and left state budgets high and dry. Multiple attempts by Congress to settle the matter ended in a virtual stalemate and led states to take matters into their own hands.
The result was a mad rush by states to hang nexus tags on everything from remote employees to trade shows to advertising (commonly called click-through and affiliate nexus). Some states boldly set aside the physical presence mandate altogether with economic nexus, which bases the obligation to collect and remit sales tax solely on the volume of sales or revenues into a state regardless of whether the company meets any other nexus criteria. These are addressed in more detail in the report.
Software taxability: The gray cloud in the black-and-white world of sales tax
More customers are choosing to buy products and services online. Both businesses and consumers are opting out of physical goods and services in favor of digital downloads, web-based programs, streaming media, and SaaS offerings.
This new virtual reality challenges the physical presence parameter by which nexus is determined and poses a quandary for states in having to apply tangible personal property rules to intangible goods and services. States differ widely in how they interpret sales tax rules related to software products and services. In fact, at one point, data showed that software was taxed numerous ways across multiple categories. And the state tax survey details more than 120 different ways in which nexus can be triggered.
A case could certainly be made that when it comes to sales tax compliance, software companies have it the hardest. The good news is that all the things that make software taxation difficult make the decision to automate compliance an easy one.
Download the report for more insights: Nexus and Multistate Taxes: A Brave New World for Software Firms.