Sales Tax: What Indie Game Developers Need to Know

Game development creates alternate worlds, characters, and a highly entertaining shared experience. But it's also a business, and businesses need sales and growth to survive. And the impressively large number of companies that sell video games online with large volumes of indie game sales prove this fact. Managing your business transactions requires a particular set of skills, one of which is understanding a significant source of earnings for governments worldwide: taxes.

Sales tax scaling can be extremely difficult to navigate, especially if you're a growing and expanding business focused on selling digital goods and services such as games.

In 2020, the already flourishing gaming industry grew 12% from $120.1 billion to $139.9 billion. That’s a number that is so big it is hard to wrap your brain around it. Furthermore, as online video gaming continues to explode in popularity, so too does the complexity surrounding the tax obligations on these services. 

Countries worldwide are quickly learning how to make digital services subject to tax and leverage the industry growth to their advantage, increasing their income. In the U.S., individual states are also starting to realize there is good revenue to be made from the online gaming industry and have the ability to put into place new tax laws benefiting their local jurisdictions.

Are you wondering if your business complies with all the different tax issues worldwide? We are here to help by providing you with this sales tax for game devs' article.

What Is Sales Tax?

Sales tax is collected by a retailer from its customers or users whenever a transaction is made. Subsequently, the retailer is required to remit this money to the relevant tax authorities, according to the laws of that jurisdiction.

As a game developer and the sole proprietor of the good, you may need to charge SaaS online sales tax in certain jurisdictions where customers have paid for your product or streaming services. When it comes to digital products, it applies in many U.S. states and other foreign jurisdictions. There are so many different tax rates and new laws in various countries and states and sometimes differ even by zip code. No matter how complicated tax management is, you will have to focus on following the correct steps to avoid having to deal with the IRS. Stay far from sales tax mistakes in SaaS is essential. 

2 Tax Complexities for Game Devs

Digital Products and Tax

Tax was rarely applied to digital services and products in the past, as many states had no laws or regulations controlling this category. The reason is that many of the laws around sales taxes were conceived before digital goods existed and certainly before they were such an essential part of mainstream life, not to mention a source of income. Some tax regulations were created with "mail-order" companies in mind, but this did not take into consideration the booming world of eCommerce. However, the landscape is catching up and steadily changing to keep pace with today's digital world.

Indie games fall into the sixth category. 

These products often don't fit nicely into state sales tax definitions and laws. It applies typically to "tangible physical property," but an online, streamed video game cannot be held in one's hands. Some states try to apply the tangible physical property tax rule to online games, as they can be seen if not touched. Others don't charge tax on them at all as they're considered intangible. Alternatively, some states use the same rules for all types of products. Most confusingly for gaming business owners, some states offer no definitions, guidance, or regulations for the taxation of non-tangible products. This costs video game companies in different industries various resources, specifically of a financial nature. Indeed, we’re talking about lost income. 

The taxation of non-tangible products is also subject to regular change as states attempt to understand all the definitions and changing taxation needs. To cut down some of the confusion, entrepreneurs can easily find plenty of resources, including helpful articles containing complete lists of states that expect the payment of the sale and use of software and those that don't.

Defining the Source of Video Game Purchases for Tax Purposes

Generally speaking, determining whether or not to tax a transaction, how much to tax, and when to acquire and remit tax depends on where the customer paid for the product or service. This is considered the source of the sale. Usually, the location of the purchase or the buyer's address determines whether a taxable income is applicable. 

With virtual products, especially gaming, the source of the sale can be hard to define. And as a result, so is the taxable income. A perfect illustration of this is when a game is purchased by other gamers with virtual money because it will contain no location information from the customer. Another scenario is when a customer's home might be in one state, but they're traveling and making payments from another state or even a different country. 

It’s become painfully obvious that these complications within the existing tax treaties and regulations can make compliance more challenging than ever. The U.S. Government passed the Digital Goods and Fairness Act of 2019 to resolve some of these issues. Under this act, states must use a customer's address to apply taxes. It also seeks to implement fair taxes on payments for digital goods or services with similar rates to tangible products. Texas was the first state to issue a specific ruling on tax sourcing on digital goods and services. Private Letter Ruling No. 2017010107 states that a "taxpayer may use the Registration IP address associated with a physical address in Texas in place of the purchaser's business or residential address."

Where and When Does Your Business Have To Pay Sales Tax

While you may find plenty of information sources from guides to handy state-by-state articles on sales tax applied to non-tangible products, you should still make sure you’re constantly doing your research because the regulations change rather frequently. For further clarification, each state also has a site with information on its sales tax which you might find helpful. Indeed, given the complexity of the topic itself, visiting a website, reading an article, or doing a quick search over the internet will not cut it this time. Having an experienced accounting team with significant knowledge of tax legislation is advantageous. It certainly beats the information extracted from an article. 

Unfortunately, you'll have to analyze each country and jurisdiction where your business has an economic nexus for international sales. For instance, digital businesses selling their goods or services in Europe must apply, collect, and remit Value Added Tax (VAT) for all purchases. Additionally, it is essential to note that each European state has a different VAT rate.  As you can imagine, tax management is a rather complicated operation, and there is a lot of pressure to make sure you are doing this correctly. Tax liability is a very serious matter and should be treated accordingly. Any error in the tax-related procedures could make your company subject to fines, affecting your overall revenue gains.

U.S. Tax Code Incentives for Gaming R&D

With an increasing number of people now seeking entertainment from the comfort of their homes, there's a high demand for most types of non-tangible products and video games in particular. This situation has created a gaming environment where there's stiff competition. As a game developer looking to increase your income, you must keep innovating, growing, and evolving to stay relevant and competitive. This procedure can be expensive, especially if you're still relatively small.

Luckily, the U.S. Government has implemented a Research and Development (R&D) tax credit, which provides credits to offset the expenses involved in these growth processes. 

There's a common misconception that R&D only applies to science and engineering projects. But in reality, if your activity contributes to new or improved practices, it's considered R&D. Improving your operations and sales can even be considered "research and development." Another great benefit is that the tax credits don't only apply to physical products -Software is also covered. 

In other words, your company may be able to claim deductions for the development and improvement of your products. For instance, algorithm development, beta testing of new games, innovating technology for interactive content, engineering new devices for better performance, and improving your manufacturing mechanism could qualify as R&D. 

If your company is eligible, you may claim the total amount you spent on qualifying R&D activities within a year. You can also claim back credit for up to three years and carry forward unused credit for 20 years.

You'd also need to prove that you performed this R&D work in an experimental environment, using scientific methods and protocols.

It’s important to stress that claiming those deductions requires ample evidence and documentation. When doing so, we recommend consulting a professional to make sure you're getting advice from a specialty tax provider who can manage the complex incentive process and help you generate a comprehensive report.

5 Steps How To Manage Your Business' Sales Tax

When it comes to managing your royalty payments and tax-related issues in the day-to-day life of your business, it's essential to stay well informed to be assured you are always in compliance. Books like The Definitive Guide to Taxes for Indie Game Developers provide helpful industry-specific tax information. 

Take a look at these five practical tips to keep the process running efficiently and smoothly so companies can stay on top of all tax issues, requirements, and regulations.

Track Every Dollar

To manage taxes on video games efficiently and compliantly, you'll need to keep thorough records of your sales and where they originated. Keep these records organized and accessible at all times. Again, don't be afraid of consulting professionals ‒ a good accounting service can make all the difference!

Stay Ahead of Payment Deadline Dates

The timing of tax remittance can vary from state to state, so you'll need to keep an online calendar to help you stick to deadlines. Some states require tax to be remitted monthly, while others expect it quarterly or yearly. Don't forget that public holidays and weekends may affect when you need to pay tax.

Know How to Remit Sales Tax

Research how each applicable jurisdiction expects the tax to be remitted. How do the jurisdictions accept their sales tax payments, for example? Thankfully, you can access this information on each state's sales tax website.

Get The Proper Permits

Every business needs a sales tax permit to pay taxes. If you understand economic nexus, you can track the states where you have reached nexus and apply for the relevant sales tax permits there. Again, do not hesitate to use a professional regarding tax issues since errors can be detrimental to your business.

Understand the Penalties

Tax non-compliance can come with hefty fines and penalties. And there's nothing like avoiding fines and legal action to keep businesses motivated to raise taxes correctly. Do your research, and check the many existing resources to understand the consequences of mistakes and how to avoid them. It is not possible to overemphasize this point!

3 Common Sales Tax Mistakes To Avoid

Sales tax can be a bit of a minefield when you're inexperienced or running complex operations. But it doesn't have to be a heavy burden on your business if you plan accordingly. Here are the top mistakes companies make and how to avoid them and become subject to hefty fines.

The Taxation Process in 7 Steps

Misunderstanding economic nexus

In this world, "nexus" is the connection a seller must have with an area before they're required to charge and gather sales tax there. Where this gets confusing is in the understanding of the concept of nexus in different jurisdictions. Economic nexus is a monetary threshold rather than a physical one and can depend on sales revenue or several transactions. Nexus rules differ from state to state and also in other countries. It's therefore vitally important to do your research on where your game sales reach the economic nexus and fully understand these concepts.

Failing To Monitor Different Jurisdictions

Keep checking the rules in the tax jurisdictions that apply to your business. The regulations surrounding different jurisdictions often change without notice. For instance, as of 2021, Kenya introduced a 16% sales tax, and the registration threshold is 0. States keep changing their requirements for taxing digital goods, so as a game developer looking to expand across borders, you'll need to stay on top of the new rules. As they say, ignorance of a law is no excuse!

Taxable Products

The tax world is still catching up to the relevance of taxing video games. In different jurisdictions, streaming services or online games can be considered "tangible personal property" or "intangible personal property." This changes game taxability, with many difficulties in differentiating the two categories. Your business will probably have its unique combination of taxable products, which is different from other businesses (even others in the broader digital industry).

We recommend working out where you've already got nexus and then looking into what products are taxable in those jurisdictions.

Sales Tax Exemptions Errors

A sales tax exemption certificate allows clients to purchase a product that would typically incur taxes without paying taxes on that transaction. As the game developer and owner, you need to check that exemptions applying to your products and services haven't expired or become invalid, or you'll be liable for uncollected taxes and therefore could face penalties.

Not Communicating Clearly With Clients

Clients need to know if you're collecting sales tax on the games you sell, and they generally want the taxable amount included in the total shown to them when they make purchases. If you don't include it, you'll have to explain why. We recommend making this clear on the invoice, as shoppers expect to see the price broken down with a total showing product price plus tax.

Collecting Incorrect Tax Amounts

If you misunderstand taxable amounts and taxation periods, you could be collecting and remitting the incorrect tax. Besides being a threat to your business reputation, you could also be fined for non-compliance. With the help of professionals, you avoid these errors and sleep better at night, knowing everything has been done to meet these changing requirements.

Automation Mistakes

In many ways, it's easier to automate tax matters, as you can rely on software to simplify complex processes. However, this can backfire when regulations change and your software doesn't automatically adjust. To be both efficient and compliant, you might automate only the essential tax collection and remittance features and keep manual control over the rest.

Filing Incorrectly

Not Filing

You need to file tax returns in many states, even if you haven't collected any tax within that filing period. It may come as a surprise to many that these states require a "zero return" statement. Don't risk being labeled non-compliant or fined over something as small as this. 

Incorrect Reporting and Computational Errors

Let's say you're filing taxes across multiple jurisdictions, and your tax return comes back with errors. It turns out that one state required you to round numbers up, while others required rounding down. Such a small thing can derail your compliance and affect the company’s overall revenue, so again, we cannot stress enough how important it is to keep up to date with each jurisdiction's reporting rules or work with a professional who will ensure this is not overlooked.

Filing Late or Not Often Enough

Filing your taxes late will undoubtedly add unnecessary stress and financial strain to your business. You'll still be required to file when auditors flag for late remittance, even though it's past the deadline. The best way to avoid this situation is to create a schedule in your calendar (with several reminders) and save all your deadlines, including the specific dates until which you need to report taxes. The important part is knowing and fully understanding when these deadlines occur!

Forgetting Important Information

When you submit your taxes, the devil is in the details. This means you must check every document to ensure that you've met all requirements and filled in every field. Also, double-check that you've signed in every relevant place. Some states will reject a sales tax form because of small details such as this.

Maintenance of Sales Tax

Failing To Keep Up With Changing Tax Regulations

You will need to make it a top priority to monitor tax regulations in all the jurisdictions where you have nexus.  As we have mentioned, changes are frequent and often unexpected and cannot be underestimated!

Not Challenging Negative Auditing Findings

It’s possible you may come up against a negative audit finding. If this does occur, consult the professionals and also be sure to check on your rights and responsibilities around challenging the result. In some circumstances, it can be beneficial to challenge these results.

Trying To Go It Alone

Many new and even more experienced developers make the mistake of trying to manage complicated sales tax matters without any help. Sales tax experts can ensure your tax collection and remittance go off without any costly hiccups. When looking for a tax professional, don’t forget to focus on finding someone who knows and understands the gaming industry.