California’s New SaaS Tax Key Implications for Software and Technology Companies

Introduction

On June 29, 2026, Governor Gavin Newsom signed SB 122/AB 122 into law, enacting California’s first-ever sales and use tax on software-as-a-service (SaaS) and prewritten computer software transferred electronically or accessed remotely. The new law takes effect January 1, 2027.

The law marks a significant shift in California’s taxation of digital transactions. Previously, electronically delivered and cloud-hosted software were excluded from the sales and use tax base. California now joins the growing majority of states that tax cloud-based software.

The California Department of Tax and Fee Administration (“CDTFA”) estimates the change will generate approximately $1 billion in combined state and local revenue in fiscal year 2026–27, while acknowledging uncertainty due to the new tax base.

Businesses that sell or purchase SaaS, cloud-hosted software, or electronically delivered prewritten software in California should begin compliance planning now. Although the law provides a six-month implementation period, organizations with complex digital product portfolios may require significant lead time to prepare.

Scope of Taxable Products

1. What Is Taxed
   

   SB 122/AB 122 amends the definitions of “sale” and “purchase” under the Revenue and Taxation Code to include permanent or temporary transfers of the right to open, view, access, download, copy, update, possess, store, manipulate, or otherwise use a “digital product” transferred electronically or accessed remotely. The bill defines a “digital product” as prewritten computer software delivered on tangible storage media, transferred electronically, or accessed remotely (including SaaS and other cloud-based software).

2. Key Statutory Definitions

   1. “Transferred electronically” means obtained by the purchaser, by means other than tangible storage media, in a manner that allows the purchaser to open, view, access, download, copy, possess, store, manipulate, update, or otherwise use the digital product.
   2. “Accessed remotely” means accessed for consideration by use of a digital code, password, or other means – prewritten computer software that resides on the vendor’s servier or the server of a third party.

3. Applicable Rate
   

   The tax applies at California’s full combined state and local sales and use tax rate—currently 7.25% at the state level plus applicable district taxes (which can push the effective rate above 10% in many jurisdictions). This is not a reduced or preferential rate; it is the same rate applicable to tangible personal property.

Exclusions & Open Issues

Express Exclusions

SB 122/AB 122 explicitly excludes from the new tax base a number of digital products that might otherwise be swept in:

• Custom software (software developed to the specifications of a purchaser)
• Digital assets (including cryptocurrency)
• Digital audio and visual works
• Digital books
• Digital infrastructure
• Digital video games
• Streamed media

The exclusion of custom software preserves a longstanding California principle. However, the line between “custom” and “prewritten” software has historically been a significant source of disputes.

Open Issues Requiring CDTFA Guidance

The bill is silent on several recurring software taxability questions that will likely require regulatory guidance or rulemaking by the CDTFA, including:

• The line between custom and prewritten software, particularly for heavily configured enterprise platforms
• Bundled transactions involving taxable software and exempt services or digital products
• Application of Technology Transfer Agreement (TTA) principles to digital licensing
• Interaction with existing exemptions, including the manufacturing equipment exemption for embedded software
• Transition rules for multi-year contracts spanning January 1, 2027
• Treatment of free trials, freemium models, and usage-based pricing

Until the CDTFA issues guidance on these topics, taxpayers should document their positions and the facts supporting them.

Sourcing & Collection/Payment Responsibility

Sourcing Rules

The bill establishes the following sourcing framework:

• In-person sales: Sourced to the seller’s location.
• Remote transactions: Sourced to the purchaser’s known address in California, using the following priority order:
  • Billing address
  • Shipping or delivery address
  • Mailing address associated with the payment instrument; or
  • Purchaser’s most recent mailing address on file

Large-Transaction Liability Shift

SB 122/AB 122 introduces a novel mechanism shifting collection liability from the retailer to the purchaser for certain high-volume transactions:

• Effective January 1, 2027: If a retailer’s gross receipts from sales of digital products to a single purchaser (transferred electronically or accessed remotely) exceed $5,000,000 in the current calendar year, the purchaser assumes liability for remitting the tax.
• Effective January 1, 2028: The threshold is measured on either the current or preceding calendar year, creating a look-back mechanism.

This provision will primarily affect enterprise-scale software procurement relationships and will require contractual coordination between vendors and purchasers regarding tax collection and remittance obligations.

Practical Implications for SaaS Vendors & Software Publishers

1. Registration requirements
   Vendors with California nexus (economic or physical) must register with the CDTFA and collect tax on covered transactions beginning January 1, 2027.
2. Product classification
   Each software product or service offering must be evaluated to determine whether it constitutes taxable prewritten software or excluded custom software, digital media, or other carve-out.
3. Pricing and contract impacts
   Existing contracts should be reviewed for tax-inclusive vs. tax-exclusive pricing provisions. New contracts should address the allocation of tax obligations, particularly for transactions that may trigger the $5 million liability-shift threshold.
4. Systems and processes
   Tax engines, billing systems, and invoicing processes must be configured to apply the correct rate based on purchaser location, collect and validate exemption certificates, and track cumulative sales for the large-transaction threshold.
5. Exemption certificate management
   Vendors should anticipate increased demand for resale and exemption certificates from business purchasers.

Recommended Actions for 2026

With the January 1, 2027 effective date approaching, organizations should begin compliance planning in 2026, particularly those with complex digital product offerings or multi-state operations.

1. Conduct a Digital Product Inventory
   Identify all prewritten software, SaaS, and electronically transmitted solutions that the organization sells or purchases in California.
2. Perform a Nexus Study
   Evaluate whether California nexus triggers collection obligations, including the state’s $500,000 economic nexus threshold.
3. Assess Current Tax Treatment
   Determine the current sales tax treatment of each digital product and identify transactions that will become newly taxable.
4. Review Contracts
   Audit existing customer and vendor agreements for tax-related provisions, gross-up clauses, and pricing structures that may be affected.
5. Update Tax Engine and Billing Systems
   Configure tax software to apply the correct rates, product taxability codes, and purchaser-based sourcing.
6. Establish Exemption Certificate Procedures
   Implement or update processes for collecting, validating, and storing exemption and resale certificates from customers.
7. Register with the CDTFA
   If not already registered, complete registration before the effective date to ensure timely collection and remittance.
8. Train Cross-Functional Teams
   Ensure that tax, finance, legal, sales, and IT personnel understand the new requirements and their respective roles in compliance.
9. Monitor CDTFA Guidance
   Monitor CDTFA regulations and guidance on definitions, bundling, exemptions, and transition rules.

Implementation & Regulatory Outlook

CDTFA Rulemaking and Guidance: The CDTFA will need to issue regulations or guidance addressing the open questions noted above. The timeline for such guidance is not yet known.

Industry Challenges: Given the magnitude of the revenue at stake and the novelty of the tax base, legal challenges by affected industries are possible.

Bundling and TTA Guidance: The treatment of bundled SaaS-plus-services transactions and the applicability (or inapplicability) of TTA principles to digital licensing will be closely watched.

Multi-State Coordination: As more states tax SaaS, businesses should monitor developments in the Streamlined Sales Tax Project and potential federal legislation regarding digital tax uniformity.

Local District Tax Implications: The interaction between the new tax and California’s numerous special district taxes will present compliance complexity, particularly for sourcing.

Contact us for more information

Connect with our team to assess how California’s new digital products tax may affect your business and prepare for the January 1, 2027 implementation.

Scale’s Communications & Technology Team

Our Communications & Technology team advises companies at the intersection of innovation and regulation. We work with telecommunications providers, infrastructure companies, and technology platforms to navigate complex federal and state frameworks, execute strategic transactions, and manage day-to-day regulatory demands.