This is the third installment of Miles Consulting Group’s series SaaS Tax Watch, 2027 and beyond. Click here to read Blog #1 and Blog #2.
On September 10, the California Department of Tax and Fee Administration (CDTFA) hosted a second interested parties meeting related to SB 122, which expands California’s sales tax base to include “digital products” as taxable tangible personal property as of January 1, 2027. Despite California’s reputation as a tax unfriendly state, the historical sales tax base was narrow relative to many other states. The inclusion of digital products (and within it, SaaS) marks a substantial expansion of the sales tax base. Prior to the meeting, the CDTFA published a discussion paper on the topic, with draft regulatory language included as exhibits. The agenda for the meeting is linked here.
Miles Consulting Group participated in the meeting with CDTFA officials and other practitioners. The tenor of the meeting was that the current draft of the regulations leaves as many questions as it does answers, and there are still clarifications to work through as part of the rulemaking process. The majority of the discussion focused on three areas:
- Place of sale,
- Imposition of tax on long term software agreements that bridge January 1, 2027,
- Multiple points of use.
We break down these topics, as well as the general imposition of tax on electronically downloaded software and software accessed in the cloud (SaaS) and the next steps in the rulemaking process below. We recognize that readers may be purchasers of software products in California, sellers of software products to California customers, or both. Our recommendations below provide some insights into the practicalities associated with each.”
Imposition/Taxability:
What is clear:
Digital products will be subject to sales tax on January 1, 2027 and beyond. The definition of digital products includes SaaS.
What remains gray:
As with any tax law change, there will be product and service offerings on the margins where application of the new guidance/definitions remains unclear.
For example, California provides an exception for services that primarily involve human effort. We note that Washington State previously had a similar human effort exception from its digital automated service regime, which in practice was almost impossible to sustain in audit defense. It is unclear where the CDTFA will draw the line on services that include both digital and human elements.
Further, it is unclear how California will apply true-object rule concepts to the newly taxable services, for example, a telecommunications service (nontaxable) provided over a SaaS platform (taxable effective January 1, 2027).
A request was made during the meeting to provide more specific examples of common services that the CDTFA will treat as taxable versus nontaxable; it is unclear what additional details will be provided.
Our Recommendation:
Sellers: Consider the pricing and packaging of your services for taxability. Update billing and ERP systems to support California requirements.
Purchasers: Include California sales tax in your budgeting process.
Place of Sale:
What is clear:
A sale of a digital product is deemed to occur in California if the purchaser’s address is in California. If the seller has multiple addresses on file, the regulation provides an order of prioritization: 1) billing address, 2) shipping address, 3) mailing address associated with the payment, and 4) purchaser’s mailing address.
What is gray:
While digital products are not physically “shipped,” in practice many sellers’ invoice presentation may still show both a bill-to and a ship-to address, which may or may not match. There was lengthy discussion in the meeting regarding this type of invoice presentation, as well as the seller’s obligation to try to ascertain customer location. The CDTFA indicated that sellers can rely on an out-of-state address supplied by the buyer for the current transaction. It remains to be seen whether auditors will take a more aggressive approach in the future against sellers who have multiple addresses, or who previously had California addresses for a particular customer.
Our Recommendation:
Sellers: Review your systems and records to determine what address(es) you have on file for your digital product customers. Confirm that your tax engines will properly follow the address prioritization for determining place of use in California.
Purchasers: If you provide a non-California address to your vendors, consider to what degree you may be making a taxable use of software in California.
Imposition of Tax on Long Term Software Agreements that Bridge January 1, 2027
What is clear:
CDTFA officials stated during the meeting that 1) they do not intend for the tax to apply retroactively to periods prior to January 1, 2027, and 2) their focus for determining the timing of the sale is whether the customer gains the right to access before or after January 1, 2027, regardless of when consideration is paid. The proposed regulations provide five examples scenarios to help guide taxpayers.
What remains gray:
There was lengthy discussion on this topic during the meeting, along with requests for additional examples. Specific points of contention were the seeming confusion between a monthly subscription versus a monthly financing arrangement (examples 4 and 5), as well as a lack of clarity on seat-based charges where a company’s right to access may begin in 2026 but the number of seats may increase in 2027.
Our Recommendation:
Sellers: Review and understand the structure of your existing agreements that will bridge the January 1, 2027 effective date. Does the contract provide for a single access period, or a series of recurring subscription access periods? If the latter, it appears that tax will apply to access periods that begin in 2027.
Purchasers: Consider timing of entering into long term software contracts, determining whether any such costs could be accelerated into 2026.
Multiple Points of Use (MPU):
What is clear:
California retailers are not obligated to collect and remit sales tax on the portion of software used outside California, as documented to them by their customer. This is a unique approach relative to other states with MPU exemptions, which generally relieve the seller of tax collection altogether and shift the burden to their consumer, who has better visibility into their own use of the software inside and outside of California.
What remains gray:
The CDTFA’s approach will create administrative challenges for sellers, as the California use percentage may fluctuate during the year, which could potentially mire sellers in refund claims or true-ups. Further, the regulation gives the CDTFA power to prescribe any forms and documentation necessary to administer the MPU exemption, but it is unclear exactly what those will look like.
Our Recommendation:
Sellers: Start conversations with customers to understand whether they will avail themselves of the MPU exemption.
Purchasers: Establish a process to identify the percentage of use inside and outside of California.
Emergency Rulemaking:
What is clear:
The CDTFA will finalize emergency regulations on SB 122, which may remain in effect for up to two years.
What remains gray:
Timing and content. The CDTFA estimated that taxpayers would receive notice of the final language sometime during December. It is unclear how much time taxpayers will have to review the latest guidance during the busy holiday season leading up to the January 1, 2027 effective date. Further, as outlined above, there were numerous requests for additional examples in the proposed regulations – it is not certain how many new examples will be included, and to the extent they are, how much clarity they will provide.
Our Recommendation:
Sellers and Purchasers: Stay tuned for further updates!
In the next few months leading up to January 1, we will continue to share updates as new information becomes available. Until then, please reach out to us at info@milesconsultinggroup.com with any questions. Additional updates on the informal rulemaking process are available on the CDTFA’s website
