Some U.S. SaaS Companies now Subject to new Canadian “Economic Nexus” Sales Tax Compliance
A cooling wind from the North Country may have been the fervent wish of many as relief from the heat waves blasting much of the U.S. this summer. Alas, only the cold, hard fact of yet another sales tax compliance burden has blown in to chill the bones of certain U.S. software companies selling to our neighbors in the north.
This change comes just as companies are beginning to recover from the effects of U.S. sales tax economic nexus rules blessed by SCOTUS in the Wayfair case during the summer in 2018. States throughout the country have since enacted some flavor of these rules in the intervening years, and businesses have struggled to both keep up and comply.
Now, effective July 1, 2021, some of these same U.S. companies became subject to new Canadian sales requirements for registration, tax collection, reporting and remittance. These rules, intended to enhance collection of tax revenue from sales of digital products and services, including subscriptions for Software as a Service and related services to Canadian consumers, specifically target nonresident sellers. They are applicable even when there is no physical connection between the U.S. seller and Canada.
While I’m playing a little fast in using the economic nexus nomenclature here (Canada does not use the familiar U.S. nexus concept, and views this as simply a registration and tax collection obligation on nonresident companies), the effect of the law change is equivalent. Now, if a company has sales in excess of $30,000 CAD in 4 successive quarters, registration and collection is required.
I suppose turnabout is fair play, as our economic nexus rules for U.S. sales tax do not respect our northern border. Whether they know it or not, many Canadian companies are currently accruing liability for U.S. sales taxes on their southward sales.
While this writing is focused on SaaS companies, other digital goods and services are also subject, as are digital sales platforms that operate in the Canadian marketplace. In fact, to the extent a company sells taxable items through such a platform, tax must be collected by the platform rather than the seller (and those sales would not count towards the $30,000 threshold).
Let me again emphasize that this tax burden is generally only applicable to SaaS companies that sell directly to individual Canadian consumers. Even though there may be a technical registration requirement, Companies that sell substantially all products and services to business customers should not incur any material liability. This is because Canadian businesses are already required to be registered with the Canada Revenue Agency (“CRA”) and must self-report any applicable tax liability. While individual consumers may also technically have a requirement to self-report tax due, enforcement of the tax against sellers is an easier matter than enforcement against the many, many customers of those sellers.
As for the registration process, a determination must be made whether to register under a new, expedited and simplified procedure, or under the standard method that can take 3-4 weeks for processing. Be careful here, as the simplified method may not be the more advantageous for many companies. Of note, CRA has signaled that there will initially be leniency as to the registration date so long as a company can show it is making a reasonable effort to become compliant but is not able to do so due to operational considerations.
What follows are answers to questions of a more general nature for those unfamiliar with the operation of Canadian sales taxes.
Are there similarities between U.S. and Canadian sales taxes?
I would say that there are analogies that can be drawn between certain aspects of Canadian and U.S. sales taxes. In Canada there is the Goods and Services Tax (“GST”), typically 5%, on sales throughout the country. This tax is imposed and administered by the federal government. There is also the Harmonized Sales Tax (“HST”) that is imposed, at varying rates, on top of the GST by five of the provinces (including the most populous province, Ontario, where the HST typically adds an additional 13%). The HST is a type of Provisional Sales Tax (“PST”) independently imposed by a province, but generally following the GST in terms of how it is applied. The HST is also administered by the federal government.
I liken this arrangement to U.S. states like Texas that have a state-wide rate with additional locality-based rates, all of which are administered by the state government.
Meanwhile, some provinces both impose and administer their PST. There will be many similarities among the PSTs, but there can also be differences that may be important to some taxpayers. Based on population, the Quebec Sales Tax (“QST”) is the most prominent among these “independent” PSTs.
I think of this arrangement as similar to the way some home-rule states operate. For example, Denver imposes and administers its own sales tax, imposing sales tax on Software as a Service. Meanwhile, Colorado does not tax SaaS and many localities in the state have elected to let the state administer their local tax consistent with the statewide tax.
Note that SaaS sales by remote sellers have been subject to the QST as of approximately 2 years ago, however enforcement will likely be stepped up as a result of the new rules.
All of our sales are to Canadian businesses, are there related exemptions?
No tax may be charged to a business that is registered with CRA. Since almost all businesses are required to be registered, this mechanism operates effectively the same as U.S. resale or exempt use (e.g., manufacturing) exemptions. However, no certificates are required.
Many of our sales are to charitable or governmental organizations, are there related exemptions?
Typically not as such. However, these organizations are generally required to register with CRA, so, in general, no tax should be collected from these customers.
Is there a mind-boggling array of rules that vary across the country as to what products or services are subject to sales tax?
Fortunately, no. Most products and services are subject to tax.
What are the filing requirements?
For annual sales totaling under $1.5 million CAD, an annual filing is due on March 31 of the following calendar year. Then, for sales totaling under $6 million, a quarterly filing must be made one month after the quarter end. Otherwise, filings are monthly and due by the end of the subsequent month. No mailbox rules apply here; filings must be received by the deadline.
A variety of penalty rates that are not uniform across jurisdictions may apply for noncompliance, plus interest. A voluntary disclosure program may be available in some cases.
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