Sales Tax on Subscriptions: Understanding When You’re Liable

If you're selling SaaS, apps, gaming subscriptions, or AI tools, you're probably wondering whether you need to collect sales tax. The short answer: yes, in most places. The longer answer involves navigating different rules across US states, understanding VAT in more than 100 countries, and keeping up with regulations that change constantly.

This guide explains when digital product subscriptions are taxable, where you need to worry about compliance, and how to handle the complexity without building an entire tax department.

Are subscriptions taxable? Understanding product taxability for digital product subscriptions

When ThemePunch decided to move from selling lifetime licenses on a marketplace to running their own subscription business, tax compliance was one of their biggest concerns. As founder Moritz Prätorius put it: "When you're thinking about payments, subscriptions, and compliance, there are so many things that can go wrong."

Sales tax on digital products is complex because every jurisdiction treats digital goods differently. A SaaS subscription that's taxable in one state might be exempt in another. Some countries consider your product a "digital service" while others classify it as "electronically supplied goods." These distinctions matter because they determine which tax rates apply and what documentation you need to collect.

The challenge intensifies with digital subscriptions. Unlike one-time purchases, recurring billing means you need to apply the correct tax rate every billing cycle, accounting for rate changes, customer relocations, and evolving regulations. You're also responsible for determining whether your business has created a tax obligation (or nexus) in each jurisdiction where you have customers.

For digital product companies, this creates three major problems:

1. Registration overhead: You need to register for tax collection in every jurisdiction where you meet the threshold. In the US alone, that could mean registering in dozens of states. Internationally, it means navigating VAT registration in countries where you may not speak the language or understand the legal system.

2. Calculation complexity: Tax rates change. Jurisdictions update their rules. Product categorization differs by location. You need systems that can apply the right rate to the right customer at the right time, then adjust automatically when regulations change.

3. Filing and remittance burden: Every jurisdiction expects regular filings, monthly, quarterly, or annually. You need to track what you collected, submit returns on time, remit the correct amounts, and maintain audit trails. Miss a deadline or make an error, and you face penalties.

How do you know when and where you're liable for sales tax and VAT?

The answer depends on where you're selling and how much revenue you're generating in each location.

US

Sales tax in the US operates at the state level, which means 50 different sets of rules. Most states use economic nexus thresholds, typically $100,000 in annual sales or 200 transactions in the state. Once you cross that threshold, you're obligated to collect and remit sales tax.

The complication: not all states tax digital products the same way. Some states explicitly tax SaaS subscriptions. Others exempt them. A few have unclear guidance that leaves room for interpretation. You need to track your sales by state, monitor when you approach thresholds, register for collection once you cross them, and apply the correct rate to future transactions.

Digital products face additional scrutiny because the rules are still evolving. States are increasingly closing the "digital products loophole" and expanding their definition of taxable services to include software subscriptions. What wasn't taxable last year might be taxable this year.

International

VAT applies to digital products sold to customers in over 100 countries, with rates typically ranging from 5% to 27%. The general principle: you charge VAT based on the customer's location, not yours.

For business-to-consumer (B2C) sales, you collect VAT at the customer's local rate and remit it to their tax authority. For business-to-business (B2B) cross-border sales within regions like the EU, the reverse charge mechanism often applies. When a VAT-registered business provides their valid VAT ID at checkout, they don't pay VAT to you. Instead, they account for it on their own VAT return.

Countries like Australia, Norway, Switzerland, and the UK each have their own VAT registration thresholds and filing requirements. Some require registration as soon as you make your first sale to a local customer. Others set minimum revenue thresholds before registration becomes mandatory.

The documentation requirements also vary. You need to collect and validate VAT IDs for B2B transactions, maintain proper invoices with specific details required by each jurisdiction, and keep records that comply with local auditing standards.

You focus on your product, we’ll make you globally compliant

Managing sales tax compliance across dozens or hundreds of jurisdictions pulls resources away from building your product. You need someone on your team tracking nexus thresholds, updating tax rates, filing returns, and maintaining registrations. Or you can hand the entire problem to a Merchant of Record.

Paddle operates as your Merchant of Record, which means we become the seller of record for your digital products. We're registered for tax collection in over 100 jurisdictions worldwide, and we take on all the compliance risk and administrative burden that comes with that.

Here's what that means in practice:

• Automatic calculation: We apply the correct tax rate to every transaction based on the customer's location, product type, and business status (B2B or B2C).
• Compliant collection: We collect the necessary customer information, validate VAT IDs for B2B transactions, and issue invoices that meet local requirements.
• Global registration: You don't need to register anywhere. We're already registered and maintain those registrations on your behalf.
• Filing and remittance: We file all required tax returns and remit collected taxes to the relevant authorities in every jurisdiction.
• Audit protection: Because we're the Merchant of Record, tax liability rests with us, not you.

When Iconosquare migrated 13,000+ live subscriptions to Paddle, they removed multiple tools from their billing stack and cut billing costs by 15% while ensuring 100% compliance across all their markets. Tower had a similar experience when they launched their subscription version in 2018. With Paddle handling their tax obligations, they could focus on building features for their Git client rather than tracking nexus thresholds or filing tax returns. The result: 96% year-over-year revenue growth and a 75% annual subscription renewal rate.

The practical advantage extends beyond compliance. You can price your products either VAT-inclusive (where tax comes out of your listed price) or VAT-exclusive (where tax gets added at checkout). You can localize pricing by currency without worrying about tax implications. And when regulations change (as they frequently do), you don't need to update anything. We monitor regulatory changes and adjust our systems automatically.

Removing tax complexity from your operations delivers immediate value. You avoid the cost of building and maintaining tax infrastructure in-house. You eliminate the risk of miscalculation or missed filings. And you free up your team to work on what actually drives your business forward.

Learn more about how Paddle handles tax and compliance for digital product companies, or speak to an expert to find out how we can help your business stay compliant as you scale globally.

FAQs

Do I need to collect sales tax from my first sale?

In most cases, no. US states typically have economic nexus thresholds you need to cross first. Internationally, some countries require immediate registration, while others have minimum revenue thresholds. The challenge is tracking when you cross those thresholds.

What happens if I don't collect and remit sales tax correctly?

You're liable for the uncollected tax plus penalties and interest. Tax authorities can audit past transactions and demand payment for taxes you should have collected, even if you didn't charge customers. This creates a situation where you're paying tax out of your own revenue.

Do subscriptions and one-time purchases have different tax rules?

The product type (subscription vs. one-time) usually doesn't change taxability, but it does change your operational burden. Subscriptions require you to apply correct tax rates on every billing cycle and adjust for regulation changes over time.

How do I prove a customer is a business for B2B transactions?

In regions with reverse charge mechanisms, you need to collect and validate the customer's VAT ID or business tax registration number. Invalid or missing IDs mean you need to charge VAT as if they were a consumer.