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Selling goods and services by subscription — offering automatic, recurring delivery and charging automatic, recurring payments — is an eCommerce trend on the rise. While consumers have long been familiar with subscriptions to media services such The New York Times or Spotify, the popularity of subscriptions for physical products is rising now as well.
Goods being sold by subscription range from razors (Dollar Shave Club) to the ingredients for meals you cook yourself (Blue Apron) to clothing (Stitch Fix). Even major brick-and-mortar stores, such as Starbucks (Starbucks Reserve) and Sephora (Play!), are getting in on the action.
Visits to subscription box sites grew nearly 3,000% from 2013 to 2016, according to a report from Hitwise. It’s a trend that clearly resonates with consumers and also makes a lot of sense for many sellers.
For eCommerce merchants, subscriptions can offer more consistent demand and income in a business that can be volatile and unpredictable. It also offers the opportunity to interact with customers on a long-term basis rather than in one-time transactions. Some of the benefits of the subscription model include:
- More predictable demand
- Better information for inventory management
- Increased customer lifetime value
- Improved cash flow
- The opportunity to develop relationships with customers
- A deeper pool of high-value customer data
- Lower costs for attracting customers
These benefits make subscriptions a model well worth looking at for many sellers.
Setting up for successful subscriptions
Think the subscription model could work for you? You’ll need a platform that can facilitate subscription orders and payment, for which WooCommerce Subscriptions is an excellent option. The Subscriptions plugin allows you to introduce a variety of subscriptions for physical or virtual products and services; process automatic recurring payments; allow customers to manage their subscriptions; send out automatic notifications; and more.
Pre-built subscription solutions like this make it easy for both you and your customers to take advantage of the benefits of subscriptions.
Subscription sales tax challenges
However, while the subscription model can offer a lot of advantages, it can make getting sales tax right more complicated. While it may be easy to set up recurring billing automatically, that usually doesn’t include automatic sales tax compliance.
There are a number of factors to consider in making sure you’re charging the right sales tax on your subscription sales transactions.
Knowing where you need to collect sales tax
The first thing you need to know in order to get sales tax right on subscriptions is your nexus. Nexus is a connection that your business has with a state or locality. If you have nexus in a place, you are obligated to collect taxes on all sales there, including subscriptions. It’s up to you to know nexus rules and when they apply to you.
You will always have nexus in the state where your business is physically based. But you may also create nexus in other places by establishing some kind of presence or business activity there. States are getting more aggressive in their definitions of activities that trigger nexus, so the number of different ways in which you can establish nexus are growing all the time. Some of these include:
- Having salespeople or other employees working in the state
- Regularly attending trade shows or other events in the state
- Storing goods in the state (this can also apply in some cases if you are using a fulfillment service that stores and ships your goods for you)
- Using a drop shipper that is located in the same state as the customer
- Advertising online or using online affiliate relationships to get business in other states (sometimes known as click-through nexus)
- Sales thresholds: Making more than a specified dollar amount in sales or exceeding a set number of sales transactions in a state
Nexus rules can be complicated, and as states look to increase their sales tax revenues, figuring out nexus isn’t getting easier anytime soon. But it’s still your responsibility to be aware of when you might be creating nexus — you can learn more on nexus here.
Getting sales tax rates right by location
The sales tax rate that you charge your customers is determined by location. But again, this can be more complicated than you might think, especially when you are making remote subscription sales.
In most cases, the sales tax rate will be determined by the location of the purchaser (destination-based), but there are some instances in certain states where the sales tax rate will be based on the seller’s location (origin-based) instead. In order to get the right rate, you need to know whether you should base the rate on the origin location or the destination location. (Learn more here on origin vs. destination sales tax).
Once you know which location to use to determine the sales tax rate, you need to make sure you factor in all the taxes that are required for that location, which can include city, state, and other local taxes.
Beware of calculating rates based on ZIP codes, though. Sales tax jurisdiction boundaries and ZIP codes may not always align. That means that one ZIP code can contain several different tax jurisdictions, for instance.
The most accurate way to determine the right rate is by using the precise geolocation of the transaction.
Getting sales tax rates right by product
It’s not only location that can make a difference in sales tax rates; rates may vary according to the type of product or service as well.
For example, many jurisdictions exempt unprepared food from sales tax – while others add extra taxes onto items such as sugary soda drinks.
In some states, digital products such as e-books are taxed the same way as their physical counterparts, but in many, they are taxed differently based on their format.
The following products can be particularly problematic in terms of product taxability. The rules and definitions for these products can be complicated and tax rates may vary quite a bit from jurisdiction to jurisdiction.
The bottom line is that you should never assume the tax rate for a product or service that you are selling. Make sure that you know the right rate based on the specific item in order to get sales tax compliance right.
Documenting sales tax-exempt transactions
Certain items can be exempt from sales tax depending on who is buying rather than the product itself. A sale may be exempt because your buyer is a reseller rather than an end consumer, or because your customer is exempt from paying sales tax for another reason, such as being a government entity.
However, when a normally taxable sale is exempt, you need to prove it to tax authorities with an exemption certificate to show that no sales tax was due. Exemption certificates should be collected anytime a tax-exempt customer is buying from you for the first time, or when a certificate you have on file for an existing customer is invalid or is about to expire.
Keeping track of sales tax rate changes
One of the biggest sales tax challenges for subscription sales is that, although the sale occurs automatically at a recurring interval, the sales tax rate may not be the same every time. This could be because the rate has simply changed in that jurisdiction — sales taxes can and do change all the time for political or even just administrative reasons. The customer may have changed their billing or shipping address, which should prompt a change in tax rate calculation as well.
A sales tax rate might also change because a sales tax holiday applies to your item. Sales tax holidays offer temporary sales tax exemptions for certain items at certain times of year (for back-to-school items in late summer, for instance).
Neglecting to accurately change the sales tax rate when needed can result in overcharging, a negative customer experience, the hassle of having to correct the mistake, and the risk of audit, penalties, or fines, so it’s imperative to keep up on any sales tax rate changes that many affect your subscription sales.
Getting help to get it all right
Keeping up with sales tax on subscriptions can seem daunting, but don’t let sales tax get in the way of the many advantages that subscriptions can offer your business. Automation can help!
For example, SkyVerge and Avalara have worked hard to ensure AvaTax for WooCommerce works seamlessly alongside WooCommerce Subscriptions to automatically calculate every transaction at the right sales tax rate. In fact, as of the plugin’s most recent version, it’s the only WooCommerce tax integration that will re-calculate tax before sending the renewal order to your payment gateway (if it allows you to modify payment totals), ensuring you always charge the right sales tax.
Avalara’s AvaTax service is also constantly updated with the latest information on rates across the U.S., so if there’s been a rate change or a tax holiday on your product, it’s always available immediately in the calculation.
AvaTax saves you the time you’d otherwise spend on figuring out the right rates. It can also offer the peace of mind of knowing that you’re always charging the right rates. That means you can put your energy into developing your business and creating a successful subscription service.
Ready to start automating sales tax for your subscriptions? Learn more about using AvaTax with WooCommerce here.