At the end of Q2 2023, the US GDP, based on purchasing power parity (PPP), stood at $26.85 trillion. The US remains the capital of the free market, and international SaaS businesses looking to go global will have to turn to the country at some point.
However, new international SaaS organizations in the US are likely to fall into avoidable compliance issues due to the complexity of the sales tax system. In the US, over 11,000 jurisdictions levy sales taxes, and each of them have unique laws and guidelines for collection and remittance.
Furthermore, the recent economic nexus standard has created a scenario where SaaS companies can become eligible to pay sales taxes in a particular jurisdiction without realizing. Luckily, we‚Äôve compiled the primary things you need to know about US sales taxes. Keep reading to find out!
International SaaS businesses selling in the US need to:
- Study sales tax laws and identify nexus points early
- Create a US subsidiary to navigate the American business environment easily
- Register in a sales tax-free state
- Know the difference between VAT and sales taxes
- Bilateral tax agreements do not apply to sales taxes
Learn about local sales tax laws
Tax laws are an essential factor that SaaS companies must consider when selling in the US. As a corporate company, you must pay federal taxes, pegged at 21%. However, it gets dicey when you hit nexus thresholds, and sales tax becomes an obligation in multiple states.
Sales taxes are administered by several local and municipal jurisdictions in the US. This decentralized system means SaaS companies need to avoid multiple compliance pitfalls. For example, failure to meet sales tax obligations timely could lead to unintended consequences for your company. This can include:
- Back taxes and compounded liabilities
- Obstructions during future merger, fundraising, and acquisition deals
- Failed sales tax audits
- Possible litigations
Tip: Use a sales tax compliance checklist
To successfully navigate sales taxes in the US, you need a comprehensive compliance checklist. This checklist will help you keep track of the critical things you need to do to stay sales tax compliant. Some points to include in your checklist are:
- Document all sales transactions
- Identify nexus points early
- Register with tax authorities
- Know the taxability status of your service/product
- Collect and remit the right amount of sales taxes
- Collect exemption certificates when required
- Keep all transaction records for sales tax audits
Create a US subsidiary
In 2018, Dana Shultz, a retired startup lawyer and business consultant in California, argued that international SaaS companies in the US market should set up a subsidiary within the country. Shultz gave two significant reasons for his assertion: litigation and customer preferences.
Firstly, the US business environment is a highly litigious one, and SaaS businesses are often at the center of court cases. Having a US subsidiary with experts and employees from within the country means you can address litigations without fear of being shut down.
Binance, the world's largest crypto exchange, created Binance US to serve its US customers and compete with local exchanges like Coinbase. This company operates with more restrictions than the global Binance platform. Even so, Binance US is always on the SEC's radar, and the commission finally sued them on June 9, 2023.
The SEC accused Binance US of circumventing the law on behalf of its parent company. Binance US accused the SEC of "extremely aggressive and intimidating tactics in pursuit of an ideological campaign against the American digital asset industry". Simply put, Binance US became a shield for the global platform in the US.
Another reason why international SaaS companies should consider having a US subsidiary is because US SaaS customers prefer purchasing from within the system. Generally, the US market is reluctant to buy digital products or services from foreign suppliers. Luckily, successful foreign companies in the US, like Spotify, figured out this secret long ago.
Spotify Technology is a SaaS audio streaming provider created and incorporated in Sweden in 2006. However, the company registered its subsidiary, Spotify USA Inc., in 2009. Fast forward to 2023, Spotify has over 100 million users in the US.
Registration and permits
The US is a free market, and residency or citizenship is not required for SaaS founders looking to sell in America. However, foreign SaaS businesses incorporate as C-Corps or form LLCs to hasten business registration with the secretary of state of their preferred location.
This registration process is done through foreign qualification. However, international SaaS businesses without a physical presence in the US can incorporate in Delaware, Nevada, Wyoming, and other states.
Tip: Delaware is the perfect state
According to Schultz, international SaaS businesses can set up their US subsidiary anywhere in the country, provided it aligns with their long-term goal and vision. However, companies that are still unsure can opt for Delaware. Delaware corporate and tax laws offer many benefits to foreign bodies looking to enter the US. For example;
- One member may incorporate Delaware LLCs; the individual or company can be a non-US resident.
- Delaware LLCs are internationally recognized as legally registered US companies.
- Delaware LLCs owned by foreign non-residents are only taxed when they make money from within the US. Income from outside the US is not subject to corporate or sales taxes.
Understand the difference between VAT and sales tax
Value-added tax (VAT) and sales tax are similar because they are both consumption taxes levied at the point of sale. However, there are a few significant differences between them.
Differences between US Sales Tax and Value Added Tax (VAT)
As an international SaaS company in the US, you will probably pay lesser sales taxes than VAT in your home country.
Determine physical nexus before hiring
Hiring in the US may seem arduous for a foreign SaaS company. When you launch your business in the US, you need people to manage your marketing, network infrastructure, sales processes, legal obligations, and finances. The professionals handling your tasks will form a physical nexus in their jurisdictions.
Before the South Dakota vs. Wayfair 2018 Supreme Court judgment, sales taxes were only levied on businesses domiciled in a particular state or jurisdiction. As a result, businesses with offices, stores, or warehouses in a particular jurisdiction were required to pay sales taxes. As an international SaaS company, you can avoid initial sales taxes by registering in the right place.
Tip: Register in a sales tax-free state
As an international SaaS business, hiring a management team is the best way to get your corporate structure up and running in the US. Therefore, register in one of these five states before hiring employees remotely. Sales-tax-free states in the US include Delaware, Alaska, New Hampshire, Oregon, and Montana.
Tax treaties don't affect sales tax
The US has several tax treaties with China, India, the UK, and Canada, among other countries. However, these treaties do not apply to sales taxes since they are levied at the state and jurisdictional level. Therefore, international SaaS companies can expect to collect and remit the accurate amount of sales taxes regardless of the tax agreements between the US and their home country.
International SaaS companies looking to break into the US market must understand US sales tax laws to avoid compliance issues. According to the South Dakota vs. Wayfair court judgment 2018, a SaaS/online company must pay sales taxes in a particular state/jurisdiction once they cross $100,000 in total sales or 200 total transactions. However, the economic nexus threshold varies from state to state.
The sales tax compliance process may be complex, given that over 13,000 jurisdictions in the US exist. However, a detailed sales tax compliance checklist and using automation software like Galvix will save you from multiple errors, pitfalls, and possible consequences of sales tax non-compliance.