High growth is almost always cause for celebration, especially among company leaders and their investors. But no matter how well a business scales for expansion, some things get ignored. And those little things can quickly become big problems. Like indirect tax compliance. Growing companies face more tax risk (and scrutiny) that any other business.
Nearly every industry, from software to tech to manufacturing to pharma, must deal with sales and use tax in some way, but high-growth companies face bigger challenges — and for good reason. Growth equals change. And with change come new or different rules and regulations — many of which may be unfamiliar territory to you (or to the companies in your portfolio) and even to the taxing authorities that enforce them.
Until recently, sales tax didn’t make the headlines or get a lot of attention from company executives or their investors. But, the tax landscape has shifted dramatically in the past few years, incenting lawmakers to reinterpret the rules and forcing companies to comply.
Blame it on state deficits
It’s impossible to tackle sales tax compliance without first understanding nexus — a company’s economic “connection” to a state based on qualifying sales activities. The growth of ecommerce created a situation states couldn’t have predicted 20 years ago: a $24 billion loss of tax revenue from buyers purchasing from sellers who have no obligation to collect and remit sales tax. That loss forced states to recognize a much wider range of activities by companies as a means to shore up growing deficits.
Arguably, high-growth companies are hit the hardest with respect to sales tax complexity.
Here are 5 reasons why:
1. Domestic and global expansion
Physical expansion is still a key factor in business growth for many companies. But operating in more locations can create new tax obligations, often faster than high-growth companies can adapt. Adding staff who work remotely (or at a home office) in a new state can add obligations to register, file, and remit taxes in that state and all its local jurisdictions. Opening new warehouses or distribution centers — including drop-shipping warehouses — can similarly create new nexus connections. Having nexus in one or two states might be manageable, but once you have nexus in 5+ states, sales tax gets exponentially more complicated as rates, rules, and filing requirements can vary greatly from state to state.
Global expansion has its own unique tax challenges. Conducting business overseas is vastly different from the United States. Many foreign markets operate under the value-added tax (VAT) system, which does not follow the same assessment, collection, and payment structure as U.S. sales tax. International transactions also typically involve customs, duties, tariffs, and landed cost, each of which has its own set of rules and complexities.
2. Marketing or selling online or through affiliates
Reaching new markets is a key strategy for any growing business. And the Internet is a great revenue source, for you and for the states. Half of all U.S. states now require remote sellers to collect sales tax on ecommerce transactions. And 17 states have affiliate or “click-through” nexus laws, which don’t even require a physical presence to create tax liability — participating in affiliate programs or online advertising is enough to create that connection. For example, if an in-state online business leads a customer via links (“clicking through”) to buy something from the out-of-state online business, the out-of-state business is considered to have a presence in that state and must collect sales taxes from customers there.
These nexus triggers, sometimes referred to as “Amazon laws,” can affect companies of all sizes, but high-growth and ecommerce companies are primary targets because they are primary users of online marketplaces, digital advertising, and internet referral programs. If you use click-through marketing or affiliate programs to drive sales, be sure you understand how it impacts your nexus and tax compliance.
3. Adding products or services
Growth-driven companies are always innovating, looking for ways to break into new markets or reach more customers. However, adding new products or services to your offerings can make compliance tricky, especially in emerging industries like software and digital goods and services where tax laws haven’t caught up with technology.
Product and service taxability can be difficult to determine. And there is little consistency from state to state. Some products or services are taxable in some states, but exempt in others. Other products and services are “sometimes taxable,” adding another layer of confusion.
Software companies, in particular, are some of the hardest hit by the complexity of taxability. Software is now taxed 450 different ways based on 45 different categories, nuanced down to such criteria as physical or digital, custom or canned, software as a service (SaaS), or some combination thereof. Let’s say a software company launches a new product and allows customers to buy it both as a physical disc and digital download. Let’s also say that support and installation fees are included or available with purchase along with licenses. Depending on the exact nature of the software, any services provided, and the distribution method, this single transaction could be taxed at very different rates depending on where it was purchased, who purchased it, and whether it’s taxable or exempt or partially exempt based on state or even local jurisdiction rules.
To make matters worse, every year thousands of rate changes, product taxability rule changes, and Department of Revenue rulings are made that affect sales tax on products and services. Already in 2016, more than 24,400 product taxability changes have gone into effect in the U.S. alone.
4. Filing in multiple states
To stay on the good side of auditors, you’ll need to register for sales tax in every jurisdiction where you have nexus. Then, you’ll have to contend with a morass of filing deadlines and requirements that are different in each state. The frequency with which you’re required to file, as well as whether you’re required to prepay part or all of your expected sales tax obligations, can change as total sales made to customers in a state grow. Each state in which you file makes your compliance picture exponentially more complex, requiring adoption of new sales tax rules and regulations that can get confusing fast.
5. Gaining a high public profile
Congratulations, your company’s making the news! The journey from start-up to industry giant often happens quickly, but rarely quietly. Idea to IPO success stories are frequent headliners and investors, analysts, and consumers are swift to home in on the hottest companies to hit the market. This high visibility is great for growth, but it can be a magnet for states — and state auditors — looking to draw in more tax revenue from profitable ventures. Companies with a higher profile and higher revenues tend to be chosen for audits more often. And if you have multi-state nexus, you could be looking at multiple audits.
High-growth companies can’t afford to let sales tax to slow them down, especially those that do business overseas. State sales tax authorities traditionally watch companies closely in industries where compliance has historically been lax. One costly sales and use tax audit could spell major problems, especially if you are anticipating a liquidity event. Compliance problems multiply during high growth periods. When manual compliance starts to create problems, it’s time to automate. Dozens of business processes are now handled through software and SaaS solutions. Sales tax is no exception. Tax automation software integrated into your existing ERP, ecommerce, or billing system is an easy, affordable, and reliable way to stay on top of tax compliance as you grow.
Avalara helps make sales tax compliance simple and automatic for businesses of all sizes. Our end-to-end suite of solutions automatically determines taxability, identifies applicable tax rates, accurately calculates taxes, prepares and files returns, remits taxes, maintains tax records, and manages tax exemption certificates.
Global expansion is also handled far more efficiently, as VAT (Value Added Tax) can be tricky and prone to error. Avalara not only simplifies global tax compliance but automates many of the manual steps that cause errors.