In part one of a three-part series concentrating on the Software-as-a-Service (SaaS) model we look at the changing global indirect tax landscape and how it affects this growing economy.
‘Subscribe Now’ - two words that have become the clarion call of the online world! This simple call-to-action has come to underpin an entire business model: that of Software-as-a-Service (SaaS).
The SaaS model has transformed the software development industry connecting, as it does, users via cloud computing. There is no longer a requirement to download, install, and maintain software via regular upgrades. The SaaS model has developed rapidly, and become so popular, that it has paved the path for other models such as Platform as a Service (PaaS). Examples of PaaS include Amazon Web Services and Microsoft Azure.
The SaaS model
First, let’s distill what we specifically mean when we talk of SaaS it is important to understand the model of internet commerce that we are referring to. SaaS is distinctive for the following reasons:
- It incorporates a software licensing model
- The software is licensed by the end user on a subscription basis, pricing changes accordingly
- The software is cloud hosted, hence no requirement for it to be downloaded by the end user
- The user then, typically, accesses and enjoys the use of the software via a web browser. In practice, this means that the end user is pulling the relevant software data from a cloud-hosted server.
SaaS has been a catalyst for change, a disruptor, and an opportunity. A recent Gartner report estimated that the SaaS market (though growing at a slower rate) would be the second largest public cloud service sector, after cloud advertising. In 2017 it is expected that the SaaS market will be worth USD$46.3 billion rising to USD$75.7 billion by 2020. Gartner’s report, interestingly, provided a glimpse of the future in stating that: “By 2019, more than 30 percent of the 100 largest vendors’ new software investments will have shifted from cloud-first to cloud-only.”
Cloud-only has already been adopted by many businesses around the globe. Every office today benefits from the SaaS model be it in accounting (with Xero), project management (Teamwork), human resources (Workday), customer service (Zendesk), documentation management (Atlassian’s Confluence), or software development (Jira).
This list, of course, only touches on a selection of the Business-to-Business (B2B) SaaS elements, there is also a significant Business-to-Consumer (B2C) market. Personal document storage options such as Dropbox, Google Drive, or Box are the best known SaaS B2C offerings but there is a host of others within the anti-virus software industry, online gaming, cloud storage, computer backup and security, and digital TV.
Companies have changed the way software is created and, as a result, the consumption of this software has also been altered. Now, anyone with access to a web browser can consume such SaaS offerings. The perpetual license is no more and all purchases are on a subscription basis.
Today, as outlined perfectly in this Inc.com piece, the success of companies using the SaaS model “depends on long-term retention instead of one-time purchases.” This is where the subscription model comes into its own.
Why and how are SaaS B2C transactions taxed internationally?
The SaaS revolution created a problem for tax authorities across the globe. As the cloud-based economy has developed tax authorities have struggled to recoup the indirect taxes — such as Value-Added Tax (VAT) and Goods and Services Tax (GST) — due to them on the sale and consumption of software. The SaaS model has muddied the waters. The European Union (EU) was one of the first jurisdictions to take action when they redesigned their indirect Business-to-Consumer (B2C) tax system in 2015.
The EU Value-Added Tax (VAT) rule change of January 1, 2015, was specifically aimed, in part, at the burgeoning SaaS B2C industry.
Pre-2015, most SaaS B2C supplies were taxable in the jurisdiction where the supplier was established. This loophole in EU tax legislation led to the, completely legal, practice of companies (EU-based as well as multinationals) setting up their HQ in low-tax EU jurisdictions. Luxembourg, for example, was a beneficiary of this loophole.
The 2015 EU VAT rule change closed this loophole as it re-engineered how VAT was to be accounted for. Post-2015 the VAT rate on a SaaS B2C supply is dictated by the location of the consumer, not the location of the supplier.
Challenges for affected SaaS merchants
The challenges for affected SaaS merchants with a large B2C base was to identify the location of their end consumer and meet the additional compliance burdens inherent in the new rules.
Meeting these challenges, as we here at Taxamo know only too well from conversations with our merchants, requires a series of technical alterations to internal systems. It also eats into time and resources.
It is a major headache when dealing with the EU alone but since 2015 dozens of other tax authorities have followed the EU’s lead and now this indirect tax architecture is being applied across the globe. Since the turn of the year Russia, Serbia, Taiwan, and (from July 1) Australia have amended their indirect tax legislation so that SaaS B2C suppliers must charge the tax rate based on the location of the end consumer.
While they are bespoke differences between these implementations there is also a consistent mirroring of the EU law. For example, to identify the location of the end consumer of a SaaS B2C supply the following pieces of evidence are typically required:
- The customer’s Internet Protocol (IP) address
- Their mobile phone SIM card country code
- The BIN of customer’s credit card
- The customer’s bank billing country
- A fixed landline number
- Other commercially relevant information, such as customer loyalty cards
Now SaaS merchants with customers across the globe have to adjust their business models so as to align them with this new global digital tax reality. They now face additional burdens when it comes to complying with these new indirect tax implementations, including registrations with local tax authorities, and the collection and remittance of the indirect taxes due to the relevant authority.
How Taxamo assumes the indirect tax liability
Luckily, here at Taxamo, the problems highlightd here are the one we solve for digital merchants selling globally.
For a Taxamo demo contact us here now.
Note: Taxamo content is created for guidance only, please consult your local tax advisor.