Plugdin Insights: Is your software business losing value at the border?

Read time: 7 minutes

BDO directors Matthew De Looze, Ishvinder Bedi and Gabriel Fuenmayor discuss withholding tax, indirect tax and transfer pricing issues software-as-a-service vendors should be aware of when selling abroad.

Software-as-a-service (SaaS) product offerings are one of the tech industry’s favoured growth tricks, offering the promise of regular ongoing revenues with almost zero distribution costs. 

But selling software packages overseas is not always straightforward. National withholding rules, indirect tax regimes and transfer pricing regulations can mean the money you get from sales is less than you expected. 

Here directors Matthew De Looze, Ishvinder Bedi and Gabriel Fuenmayor explain what can go wrong - and what you can do to avoid it.

What is the issue with withholding tax and transfer pricing?

Let’s say a company in the UK has developed a piece of software and sells it overseas. They will have put a price on that software and will expect to get that amount of money. 

But in some countries, there is a requirement for the customer to withhold some of that revenue, so the company ends up getting less. 

How does this affect software businesses, particularly?

Withholding tax is not directed at software companies but it’s relevant for SaaS, because the products can easily be sold across borders.

For startups and early-stage businesses in this space, cash flow is hugely important.

Which markets and what volume of exports are affected?

You generally see it in sales to developing markets. We have seen it in South and Central America, in countries such as Brazil.

What can be done to remedy the problem?

The first thing to do is be aware of whether there is going to be a withholding tax so you can factor it into your pricing. You also need to educate your customers because the obligation to withhold falls on them. 

Bear in mind that in some jurisdictions there may be treaties that reduce or eliminate the withholding on certain goods. 

If that is the case, then you need to be able to have a conversation with your customers, so they do not end up withholding money that belongs to you by treaty. 

It’s still a manual process: you know what services you’re providing and you need to look at the domestic law in each country. 

What are the transfer pricing implications of this?

In South America there may be different withholding rates for different types of intercompany transaction, so you might have to withhold a given percentage for dividends and something else for royalty services for example. 

Hence, it is important you classify transactions correctly to make sure you are paying the right amount. From a compliance perspective, you must also show evidence that the product or service involved in the transaction was in fact provided. 

The tax authorities not only need to see evidence that the service has been provided but also that there was a benefit to the local company. 

This comes about because previously profits were sometimes diverted from one country to another under the pretence of ‘technical assistance.’ 

If you were dealing with a third party, you would not pay for technical assistance unless there was a benefit for your business.

The seriousness of the issue depends on the territory concerned - some tax authorities are more aggressive than others - and the principle of proportionality. 

What are the cross-border issues with indirect tax?

If you are providing SaaS internationally, then local indirect taxes can come into play.

If you are selling to a business overseas, there tends to be a simplification where the customer can self-account for VAT - called the ‘reverse charge’. But it’s not always applied consistently or at all. 

For example, you have territories where they don’t make a distinction between business-to-business (B2B) and business-to-consumer (B2C) sales or require overseas suppliers to register. 

With B2C sales, you may have to register for VAT in the territory concerned but this depends on local rules. This means you can be a UK-registered business with multiple VAT registrations and filing obligations. 

Therefore, understanding local rules as well as getting clear evidence showing your customer’s location and business status will be key as there is no universal rule for all countries. Good client onboarding can really help to mitigate risk here as you do not want to be stuck between two tax authorities assessing for VAT on the same supply. 

These rules typically look to generate revenue from larger digital platforms, but if you are a smaller business and you sell internationally, you could end up having the same issues as the larger operators but without the same budget to comply. 

​For withholding, indirect tax and transfer pricing issues, we can identify whether there may be a risk with a desktop review - but solving the problem will most likely involve liaison with local teams in the territories concerned.

The first point for SaaS vendors is to assess where an overseas tax risk exists and work to resolve these . For company leaders looking for an exit, the exercise may be worthwhile purely from a due diligence perspective. 

Key takeaways for tech companies

• SaaS products are susceptible to withholding tax, indirect tax and transfer pricing issues.  Withholding tax and transfer pricing can be a particular concern in developing economies. 
• The issues involved can be complex and there is no one-size-fits-all approach you can adopt to deal with them. 
• The key is to have a good understanding of your customers and to be clear about the types of goods and services you are providing, plus the nature of the transactions involved.  

Do you need support with digital strategy? Get in touch with your local BDO advisor at plugdin@bdo.co.uk.