SaaS Sales Tax: Part II – Sourcing Sales

• March 31, 2024
• Patrick Smith

Contributing Author, Steve Claflin, Manager, SALT (State and Local Tax)

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When a factory in Michigan ships its product to a customer in North Carolina, the sale is clearly a North Carolina sale.   However, when a California software company invoices a customer in New York for 100 software licenses, and these licenses might be used in any state around the country, how is this sale sourced?

All states have specific sourcing rules to determine where a sale occurs. In applying these rules, a common issue with the technology industry is what information the seller has or doesn’t have.  Because no product is shipped to an address, the seller may have no idea where the buyer is actually located. Therefore, most sellers rely on sourcing sales to the only address they collect as part of the sale – the customer’s billing address.

States generally agree that wherever the benefit of the service is received, or the location of where the software is used, is the location where the sale occurs. Unfortunately, determining this location can be difficult. This can prove to be even more difficult in the age of digital currency where a billing address may not even be needed to make a sale.

There are two other twists with sourcing as it applies to the technology industry:

• Multiple Points of Use – Many states recognize that a sale of 100 software licenses may not be properly sourced to a single state. In light of this, a purchaser may be able to provide documentation substantiating where the users are actually located, allowing the seller to source the sale to multiple states. Alternatively, a state may allow a buyer to provide an exemption certificate to the seller, claiming multiple points of use, which then requires the buyer to submit use tax in the various jurisdictions where the licenses are used.

• Sufficiency of a 5 Digit Zip Code – Many sellers do not collect the entire address of a buyer, but instead only have a 5 digit zip code which is used to validate the payment method. In many states, this zip code will be enough to obtain the proper local rate. However, in some states such as Washington or Colorado, a single zip code may potentially fall in one of several different jurisdictions with different local rates.

But wait – There’s more! – Are the activities even taxable in the state? Keep reading —> SaaS Sales Tax – Part III Taxability

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