Understanding the Complexity of Subscriptions and Sales Tax

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The subscription economy is rapidly reshaping industries worldwide; for instance, IDC’s Worldwide Software Business Model Forecast (2021–2025) notes that subscriptions are set to drive over 80% of software revenue. However, even industries not traditionally associated with subscriptions are embracing the subscription model for its reliable, recurring revenue stream. Sectors such as personal grooming (e.g., razor blades), transportation (some automakers offer premium features through subscriptions), fitness (Peloton and digital coaching), and dining (via subscription meal boxes) have jumped on board.

Consumers have embraced this shift, presenting businesses with an unprecedented opportunity to diversify revenue streams and expand rapidly through subscription models. The perks include steady revenue, fostering long-term customer relationships, and seizing upsell opportunities at regular intervals.

U.S. sales tax and subscriptions 

If your business is new to the subscription model (particularly for digital goods or services), you might not be fully aware of the impact it can have on your tax compliance. You’re likely going to be reaching new markets — your footprint can grow exponentially very quickly. That means your tax obligations can also grow exponentially. 

The first step to understanding your tax obligations is to gain a thorough understanding of economic nexus or your connection to a particular jurisdiction that requires your business to collect and remit sales and use taxes. For example, many states have thresholds for annual sales revenue or the number of transactions — exceed one of those thresholds (in that state), and your business likely has nexus in that state. If you’re selling monthly subscriptions, you can get there pretty quickly.

It’s a complex challenge because there are over 13,000 different sales and use tax jurisdictions in the U.S., and you need to know what triggers nexus in the areas where you sell.  

You also have to factor in the counties and cities in addition to the states — and they all have different rules and rates. For example, in some states, software subscriptions are taxable. In other states, they aren’t. Some counties and cities have higher sales tax rates than others. And while you’re dealing with literally thousands of different rates and rules, you also have to stay on top of changes (and these things change all the time).  

Even things like those razor blades we mentioned earlier, as well as other items that are increasingly sold by subscription, such as dietary supplements, can have interesting tax rules. For instance, a supplement that is foodlike — a powder to mix into a smoothie, or maybe one that comes in the form of a meal-replacement bar — might be exempt from sales tax in a state, while that same state could tax other supplements sold as pills. There’s inconsistency on SaaS products, too; they’re taxable in some states, but not in others. 

Adding further complexity, certain organizations are exempt from sales tax but must provide an exemption certificate. It’s crucial to maintain records for these exemptions.

It’s important to note that these challenges aren’t exclusive to U.S. companies. They also pose risks for international companies selling in the U.S., because they’re subject to the same rules. 

Value Added Tax 

There’s also Value Added Tax (VAT), which is similar to sales tax in that it applies to where a business sells, not where it’s based. The challenge of different rules and rates in different jurisdictions is similar as well, although there aren’t thousands upon thousands of tax districts. 

Add it all up, and there’s a lot to figure out. The lesson? If you’re selling subscriptions just about anywhere (and for just about anything), it’s important to factor tax compliance into your business and operational planning from the very beginning — or now, if you’re already selling subscriptions but don’t have your tax compliance dialed in. 

Why tax compliance matters 

Of course, plenty of businesses face tax compliance challenges, especially now that commerce is so globalized and marketplaces such as Amazon have helped even the smallest businesses that sell physical goods increase their reach. 

But there are a few reasons why it’s often more challenging for businesses with subscription revenue, especially digital subscriptions. First of all, you can grow very quickly, no matter the size of your business. That’s great, but it means you could add new jurisdictions where you’ve established obligations very quickly as well — even daily, depending on your growth and the nexus rules in any given state. And if you’re adding new products? Look out. 

Second, because you aren’t just making one-time sales, but instead billing on a recurring basis, errors in tax calculation and collection can compound quickly if you aren’t careful. Unwinding a year’s worth of tax errors — or more — is difficult enough when it’s just for one customer. Multiply that by tens or hundreds or thousands of your subscribers and it becomes a nightmare scenario, especially if you’re audited. 

Unfortunately, governments aren’t about to let these errors slide. They’re always searching for revenue, and with today’s technology, they’re able to uncover issues that might have gone unnoticed in years past. 

How to make taxes less taxing

Fortunately, you’re not in this alone.  

Just as you trust Chargebee to manage your subscription and revenue growth needs, you can also automate your tax compliance. The combination of Chargebee and Avalara gives you access to powerful solutions from one of the most trusted names in sales tax — integrated right into the easy-to-use Chargebee platform you’re already utilizing.

Avalara AvaTax and other products automate the entire sales and use tax process, all the way through filing and remitting; Avalara works with sales across borders, handling VAT and GST; and because they’re cloud-based systems that are updated when tax rules change, you don’t need to try to stay on top of what’s going on in thousands of jurisdictions yourself. The right rates and rules are applied automatically. Avalara can even manage exemption certificates for you. 

The power of Chargebee + Avalara reduces risk and allows your team to focus on more profitable initiatives instead of dealing with the time and hassle of sales tax.  

Want to learn more about Avalara — and find out if you’re in good shape when it comes to meeting your sales tax obligations?