Finance Essentials for Subscription Businesses | Part two
he nature of subscription businesses, how they grow, and their suitability for transcending different international markets, as well as having diverse reselling and value-add partners, means that understanding and having a firm grip on tax compliance in different regions, particularly relating to the specifics of recurring billing, is essential.
Getting this right at the start of your business development will help resolve lengthy and potentially costly issues down the line. The key to getting it right is knowing which questions to ask and seeking systems that will integrate with your subscription platform.
In this article, we look at the key areas that companies need to know about in order to ensure their subscription business is tax compliant from the beginning and as it grows.
The implications of predictable income on tax compliance
One of the many positive things about subscription business models is the recurring revenue.
However, the recurring income also has the capacity to result in recurring risk - notably in the capacity for accruing substantial sales tax compliance risk. Two things usually catch business out:
- The volume of state and municipal sales tax laws, regulations, and rates.
- The continual pace of change regarding those rules and rates.
The volume of sales tax rules and rates
For most business executives, their knowledge regarding tax compliance relates to specific regions, products, or services. The myriad of state and local sales tax rules and rates that come into play with a subscription business can be overwhelming. They are affected by multiple things, including but not limited to the following:
- The product or service characteristics
- The location of the sale
- Applicable tax holidays
- Tax exemptions
How sales tax rules and rates change
Furthermore, the rules and rates are volatile and frequently change. Therefore, it's essential that businesses have the capacity to stay up to date regarding their tax knowledge across different regions, but also that they have the systems to accommodate necessary changes as needed, quickly and efficiently. As an example for understanding the frequency and scale of changes, there are 11,000 taxing jurisdictions in the US and they collectively made 592 standard sales tax rate changes in 2020 alone.
What you need to know about sales tax compliance
While not an exhaustive to-do list, the following four areas provide an essential knowledge base on which to approach sales tax compliance in the subscription business:
Know where your sales tax obligations are
It might sound obvious, but the first thing to be clear about is where your company has its sales tax obligations. If you had a business that was located in the UK and had a physical store/office in London, for example, then it would be very clear that your sales tax obligation was in the UK.
However, with online businesses and out-of-state transactions, particularly relating to digital services, it can be much harder to determine where the obligation lies. Furthermore, what you think and what the authorities think may not be quite the same thing, so it's important to be clear about that from the start.
Determine the sales tax rate to use for each transaction
Sales tax is different in different countries, and in some cases from one state to the next. For example, in the USA it varies enormously; at the time of writing, in California, sales tax is 7.25%, whereas in Idaho it's 6%. As sales tax relates to the buyer, for subscription-based businesses sales tax is based on where an item is sourced, as well as the delivery method.
In some cases, tax relates to where the transaction took place, in some instances, it relates to where a product is shipped from, or a combination of the two. So if you have your head office in Nebraska, a daughter company in Idaho, and a customer in New York, you can see how complexity can arise.
Use the appropriate sales tax holiday for the relevant good or service
Sales tax holidays are limited-time periods where regions allow certain items to be purchased tax-free. They tend to be sporadic, so staying aware of them and actioning them swiftly (as well as stopping them) is important both for managing your subscription business finances as well as supporting your customer relationships, and even your marketing endeavors.
Understand sales tax exemptions
There are certain sales tax exemptions and these can relate either to the product, service, or status of the customer. For example, if you're selling to non-profit organizations, they might be tax-exempt, or in the UK, exemptions may include insurance or education services. In other scenarios, there may also be a Use Tax requirement when sales tax does not apply upon purchase
This is usually the obligation of the consumer, but businesses should be fully aware of where their liability sits.
Seamless subscription system architecture for tax integration
The fundamental essence of managing sales tax liability is a combination of knowledge, preparedness, and automated systems. For subscription businesses to manage their sales tax obligations effectively and transparently, tax compliance must be automatically mapped in the digital workflow of the business platform. To make that possible, you need a subscription system architecture that allows for seamless integration with tax engines.
At keylight, our platform is built for the specifics of subscription businesses as they grow. That includes manageable account hierarchies and an API-first architecture that allows businesses to easily connect and identify the parties involved in a purchase. Businesses with their chosen tax engines can seamlessly automate tax calculations in multiple territories around the world, applying up-to-date rates and regulations.
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