How To: Determine Sales Tax Sourcing for Services
It’s daunting to figure out where you have sales tax obligations. And when you are a service provider, the responsibility grows even more complicated! If you have physical or economic nexus in the states that tax services across the country, you are at risk of an audit unless you are collecting properly.
Your business is in one state. Your customer is in another. Your employee providing the service works remotely from ANOTHER state. Where do you even begin figuring out where to charge sales tax? Since South Dakota v. Wayfair, the tricky part is determining where your transaction is sourced and where you are responsible for collecting and remitting sales tax.
Keep reading to gain an understanding of the different rules of sourcing on an industry level for services…
State Methods for Sourcing of Services
When it comes to the determination of sales tax obligations, we always say “It depends.” However, there are some ways to get on the right track and be more in control.
The first step is to determine where exactly the service is being sourced. You can’t figure out taxability until you know which state has the right to tax the charge. Sourcing is always about “Which jurisdiction is in charge of this transaction?”, so when it comes to taxable services, the issue becomes, “Taxable where? Who do I pay? What do I charge?” States that tax services either follow a benefit received rule or a service performed rule. The states that use the benefit received rule will tax a service performed anywhere if the benefit of the service is enjoyed in their jurisdiction. And the states that use the service performed rule will tax a service in the location where it is performed, no matter where the benefit is enjoyed.
For example, Louisiana taxes where the service is performed and will tax a service if it is performed in their jurisdiction, even if the benefit of the service is enjoyed outside of their jurisdiction. However, if there are materials invoiced that are shipped outside the state, these are not taxable in Louisiana. (Try to figure out how your system will handle that scenario!)
Other states will tax some services based on where the service is performed. The sales tax obligation for personal services and some repair services are where the property and the owner are located in the state where the repair occurs. In Texas, the rules for security services are made very clear. Charges for providing security services to people or property located in Texas are subject to sales tax. If any portion of the service is located in Texas, sales tax is still due. While in Pennsylvania, they say that lobbying services are only taxable in the state if the benefit or delivery occurs there. Here we go again, it always “depends!” Let’s dive deeper into some of the trickiest aspects of sourcing of services.
Challenges Facing the Sourcing of Services
So, what happens when the state rules contradict one another? Interstate transactions are common, and they are only increasing in frequency.
Issues do arise when an interstate transaction is performed in a ‘services performed state’ for a customer located in a ‘benefit-received state.’ In some states, if someone crosses a state line to repair their car, one state believes the repair service is a taxable service that was done in their state, and the other state considers the sale to be a transfer of repair parts into their state that is taxable there.
Another point of contention is when there are “Multiple Points of Use.” For example, in Massachusetts the purchaser of Computer/Software Services that will be concurrently available for use in more than one jurisdiction may, but is not required to, give the vendor a Multiple Points of Use (MPU) Certificate. This shifts the obligation for the payment of the tax from the seller to the buyer. If a Massachusetts company licenses software as a Service (SaaS) for 100 employees, but 40 of the users will actually be in Pennsylvania. By issuing an MPU certificate to the supplier, no tax will be charged on the invoice. However, the buyer will be responsible for accruing Massachusetts use tax on 60 percent of the total order. They also would need to pay Pennsylvania tax on the 40% used there since it is also taxable in Pennsylvania.
What Should We Expect for the Future of Sourcing of Services?
Efforts are being made to simplify sourcing, especially sourcing for services. The Streamlined Sales Tax Program has been a leading force. The organization has written definitions intending to encourage uniform sourcing rules for taxable services.
Digital goods and services are being evaluated to determine where the service should be sourced. Historically, states sourced software to where it was delivered and stored on the server. However, with the advent of cloud computing, this no longer makes sense and states will typically source digital goods and services to the location of the user. Unfortunately, this is often not known by the seller, particularly in the business-to-business environment.