Sales tax is significantly more complicated than most business leaders imagine. Taxes can (and do) vary based on everything from what type of product is sold, to how the product is sold, to when you’re selling it, to which customer you’re selling to, and even why you’re selling it. This is standard complexity that every business faces.
But sales taxes are even more difficult for hardware-as-a-service (HaaS) companies. Finance teams at HaaS companies can’t manage or mitigate the complexity of sales taxes until they understand what they’re up against.
There are three things that make sales tax particularly difficult for HaaS companies:
1) Hardware nexus. The product (hardware) and ownership model (subscription/opex rather than outright sales/capex), which can trip tax nexus immediately
2) Multipart contracts. HaaS companies almost always offer multipart solutions with multiple line items on every contract, which complicates tax assessment
3) Bundled offerings. HaaS offerings usually entail bundling—which ultimately mean more effective solutions, but in the meantime may require unbundling by the finance team to determine tax rates
Sales tax compliance starts with establishing where your business has sales tax nexus—in other words, which jurisdiction owns the sale. Sales taxes typically apply in at least two (state and county), but often three or more jurisdictions (city, parish, special tax district, or other area). Tax rates can vary—sometimes widely—between neighboring jurisdictions, and businesses must register and remit taxes in every relevant jurisdiction where they’re doing business. A brick-and-mortar store selling art supplies on Main Street will pay taxes to the city and state, along with any additional taxes specific to their location—all the way down to the street address.
The complexity for HaaS companies is that tax nexus can be triggered by property ownership. The art supply store no longer owns the paintbrushes it sold this morning; but if you’re offering full-subscription HaaS, you maintain ownership of every piece of equipment that you deploy to your customers. So if your Arizona-based hardware company in Tucson leases a tractor to a customer in Albuquerque, you now own property in New Mexico. As such, you trip nexus in New Mexico immediately and are subject to taxes there. In fact, HaaS companies own property in each of their customers’ states and jurisdictions—tripping nexus anew with each new customer.
HaaS companies offer products and services across 8 different categories in their solution: hardware, software, consumables, accessories, warranty, maintenance, and more. Line items from each of these categories may be taxed differently, and may vary for every customer address in the country—at least when it comes to the destination of the hardware. (If a customer is renewing a software license, that could be taxed based on where the buyer and seller are located, depending on the jurisdiction, because that part of the solution is delivered over the internet.)
For a HaaS company that makes 3D printers, the solution will include not only the printers themselves, but also the software to run them, services to keep them operating, consumable inks or filaments, and more. The leased 3D printer may be taxed at 5.6%, the associated software may be taxed at 5.9%, consumables may be taxed at 6.5%, and so on. To make matters worse, those tax rates will vary depending on whether the customer for a given printer is based in Springfield, Illinois or in Palm Beach, Florida.
Many HaaS offerings—and invoices—are structured as a bundle, rather than a cluster of independent line items. Most thoughtful hardware-as-a-service companies bundle their offerings, since doing so helps to simplify the offering for customers, and to maximize the opportunity for sales and margins as a result. A core bundle should include both the required components (e.g., the hardware and the software to operate it) and the components essential to delivering the full value of the solution (e.g. a custom installation without which the hardware won’t run properly). When bundled, the hardware, software, and installation show up as a single line item on a customer invoice.
The challenge for sales tax is that each component of a core bundle may have a different tax rate. Retail stores are faced with this dilemma with gift baskets. Consider a knife-and-cheese set priced at $25, where the knife alone would cost $20 and the cheese alone costs $10 (for a total of $30 if sold independently). A retailer must ask: What percentage of this gift basket is taxable as food, and what percentage is taxable as physical goods? The answer will depend upon location:
If the 3D printer company bundles its offering such that the hardware, software, and service plan make up its core offering in a single line item, how should the company assess tax for that line item? It varies depending on the state that the bundle is being taxed in! This means HaaS Finance teams may need to apply unbundling logic to their solution in order to tax appropriately.
This is a lot for Finance teams at HaaS companies to understand—let alone keep pace with as regulations and rates evolve every day. The most well-known software company that offers tax compliance software appropriate for HaaS is Avalara. Their platform will take all the information about every transaction (location, category of every line item, and so on), and give your Finance team the tax rates for every invoice.1
At Hardfin, we’re acutely aware of the complexities HaaS Finance teams are facing. Most companies eventually have to adopt tax software that integrates with the invoicing system in order to deal with the growing complexity. You can make the entire process easier by setting up a HaaS model well upfront: clearly defining your solution and bundling your offering, developing explicit pricing plans, and writing clear contracts. A lack of clarity on your HaaS program—how you’re pitching, selling, and papering your product—will make taxes even harder down the road.
When it’s time to think about taxes for your hardware-as-a-service business, we’d be happy to help you to make sure you have the right support in place to do it right. We have resources and software to help mitigate the complexity of HaaS.
1. Such software isn’t perfect, and our team regularly encounters edge cases where there is just too much complexity for the software to understand. But having tax software represents a significant improvement from trying to track everything manually, it mitigates a lot of risk, and gives your Finance team peace of mind.