Launching a New Product? Don't Forget About Sales Tax

Leah Robinson, State and Local Tax Partner at Mayer Brown and Michael Kerman, Counsel at Mayer Brown

Leah Robinson, State and Local Tax Partner at Mayer Brown and Michael Kerman, Counsel at Mayer Brown

Imagine a perfectly planned and executed rollout for a new product. The design, marketing, and delivery all moved forward glitch-free. Consumer demand is through the roof.

Now fast-forward a few years. Imagine that a state department of revenue just sent your company a bill for 9% of every dollar you earned from every sale of this new product to every customer in the state since the day it launched.

There goes some, maybe all, of your profit margin.

You call your tax director, who assures you that your accountants and lawyers considered the taxability of the product before rollout and determined that nothing in the state’s law would subject it to sales tax. They reassure you that their analysis was correct. But they also warn you that the department of revenue’s mere issuance of this bill establishes a presumption of correctness; your company now bears the burden to prove that this tax is not owed. They also warn you that even though you have strong legal arguments, it could cost hundreds of thousands of dollars and multiple years to fight it through a bureaucratic administrative process and several layers of court review.

There goes more money, time, and important internal resources.

After discussing with your tax director, you consider just “turning on” sales tax collection going forward to stem the bleeding. After all, you’re just a collection agent for the state. But your customers don’t think the tax is owed either, or just don’t want to pay 9% more for what they are already getting.

There goes customer satisfaction. Perhaps some move to your competitor’s product instead.

One of the biggest sales tax problems faced by today’s tech companies is the overly aggressive application by state departments of revenue of decades-old laws, coupled with the inability or unwillingness of these revenue departments to consider the nuances of each company’s products. This costs tech companies hundreds of millions of dollars that should instead be hitting their bottom lines.

"The greatest tool in your sales tax defense arsenal is your product-design team."

State revenue departments have no control over the laws adopted by their legislatures, and in many states those laws are relics of the past, having not had any meaningful overhaul in decades. State revenue departments are often forced to evaluate cutting-edge technologies using tax regimes adopted when mimeographs and telegraphs were the rage. Unfortunately, these are real examples of technologies expressly mentioned in provisions that are being litigated right now, in 2023. The result is that departments of revenue feel obligated to jam the square peg of new technologies—like SaaS, PaaS, BaaS, and IaaS—into the round hole of “information services” or “tangible personal property.” Yes, they treat indisputably intangible assets and the services they provide as tangible property. (We know, we know.)

A few state legislatures have recently modernized their laws to account for remotely accessed software, digital services, and other newer technologies, rightfully attempting to bring their sales tax regimes into the current century. But even then, exceptions—and exceptions to exceptions—often swallow the rule and offset any clarity gained from such modernization.

Ultimately, your company and your tax team cannot control state legislatures or departments of revenue. But you can mitigate the impact and prepare yourself to launch more effective challenges when issues do arise.

The greatest tool in your sales tax defense arsenal is your product-design team. They know your products and the nuances of how they work better than anyone. Connect them with your tax department early and often. The more your tax team knows about your products, the more effective they can be in providing information and arguments on audit or in subsequent litigation. And if the issue can’t be resolved through an audit, your product-design team members may serve as key witnesses later, helping an administrative tribunal or court understand your product and why it should not be taxed.

At the same time, your marketing team might be your Achilles heel. States often seize upon how companies describe their own services on their websites or in press releases, descriptions that often do not align perfectly with how a product-team member would describe it or how the tax department would like to describe it in a position letter to the department of revenue. Occasionally, they are entirely at odds, leaving a thorn in your side every time you argue your position.

Connect your tax, product-design, and marketing teams early, before your product launches. Make sure they are on the same page. Make sure your tax department understands how your products work so that they can accurately describe them and effectively develop arguments. Consider how even subtle changes in product design could have very real and expensive consequences for taxability. And since technology is constantly evolving, revisit these steps regularly.