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XaaS Tax implications

Different aspects to consider when transitioning to a XaaS model

Everything-as-a-service (XaaS)” is a term encompassing all kinds of subscription business models. Products, services, and capabilities are delivered to users as services. They tend to be attractive due to their recurrent income for the supplier and the lower initial investments and easy scalability for the user. It is no wonder that businesses are introducing XaaS business models more and more. There are many variations of subscription and pay-per-use pricing models: pay what you use, freemium, micropayment, tiered access, free trials, monthly subscription fee, etc.

The move to subscription or XaaS models can have significant operational and tax consequences. And where the business accelerates, it is up to the tax and finance functions to keep up, and even to anticipate.

A query that often arises for new XaaS introductions or Xaas caling, is how to integrate this in the existing operating model. The first question to answer in this respect, is whether the existing model is fit for purpose taking into account the customer market, the geographical market and the go to market channel. More particularly, it is to be considered whether the existing distribution channels will be used, new ones, or whether a direct to customer approach will be taken. Also the question as to whether to take a (fully) centralized approach compared to a regional or even local model is to be addressed.

The choices made could have a different tax impact in terms of PE exposure, withholding tax liability and reporting, indirect tax obligations, etc, It is therefore key to address this in a timely way.

XaaS setups can trigger tax obligations in countries where customers are established, even if you as supplier have no presence in that country.

Indeed, an increasing number of countries are introducing tax and/or reporting rules specifically designed to tax digital transactions and platforms. These obligations can take different forms, such as VAT on digital or electronic supplied services, digital services tax (DST), deemed reseller rules, platform reporting rules (such as DAC7) or other platform or marketplace specific rules. Where the rules are often aimed at services provided B2C, some countries also specifically include B2B or capture some B2B transactions indirectly.

Furthermore, when transitioning to Xaas models, you may be faced for the first time with rules that specifically apply to certain services. One example are the so-called “use and enjoyment rules” which aim at taxation at the location where a service is effectively “used and/or enjoyed” . These rules are often quite difficult to interpret and apply.

Where you expand geographically and engage more directly with your customers, new tax obligations may arise compared to the current setup. You may for example become liable for the first time for sales or use tax (e.g. in the US or Canada) if you meet certain nexus rules and thresholds.

As these taxes may not be recoverable and the reporting obligations could trigger an important compliance cost, it is important to includes these considerations in the overall Xaas business case.

How to characterize XaaS offering is one of the most important questions when making the tax impact analysis. The characterization of the supply will indeed be key for VAT, GST, withholding tax, tax treaty entitlement, customs duties and sales and use tax.

Where solutions offered under a subscription model involve both a tangible and a service element, the Xaas solution as a whole needs to be analyzed: does it concern a supply of goods or services; are distinct supplies offered or is there one single supply? Do any (un)bundling obligations exist? Depending on the reply to that question, which can be governed by local rules in certain jurisdictions or for which no guidance exists in others, a different tax treatment may apply. The reply to that question could also lead to different replies or interests from a direct and indirect tax perspective, an ambiguity that companies need to manage.

Furthermore, new – often unchartered – elements are part of the overall offer. Early termination compensation, warranty and return policies, pricing arrangements and global agreements are often new or different and deserves attention on how to be characterized.

XaaS models often consist of physical elements, where goods are put at the disposal of customers without being sold. Moving around own goods, especially cross borders, can have significant tax implications such VAT reporting obligations, customs and trade obligations.

Having equipment locally could also trigger nexus and trigger local reporting obligations and/or local tax liability. A PE check is in such case a must to have on the Xaas tax checklist.

The XaaS set up and its linked VAT/tax treatment need to be implemented in the companies’ ERP system. For example, new data points may have to be considered for VAT and sales tax, there is a possible multiplication of tax codes, new invoicing requirements may apply, and specific tax point rules.

A move towards a XaaS solutions is not just a commercial move but can have significant tax changes and consequences. Make sure tax is a key considerations from the start of the project. This to help in shaping the project and timely manage complexity.

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