Sales tax vs. VAT overview

Updated on May 21, 2022

What is the distinction between sales tax and VAT? Both sales tax and VAT are examples of indirect taxes, which are levied by the seller at the moment of purchase and subsequently paid or sent to the government on the buyer’s behalf. Within the corporate tax community, sales tax and VAT are frequently confused. Let’s look at the similarities and differences between these two forms of indirect taxes in more detail.

When the final sale in the supply chain is made, the merchant collects sales tax. End users, in other words, pay sales tax when they buy goods or services. Businesses can give resale certificates to sellers and avoid paying sales tax when purchasing supplies or materials that will be resold. Sales tax is not collected until the end customer is sold, and tax jurisdictions do not get income until then.

VAT, on the other hand, is collected at each level of the supply chain by all sellers. VAT is collected on taxable transactions by suppliers, manufacturers, distributors, and retailers. Similarly, VAT is paid by suppliers, manufacturers, distributors, retailers, and end consumers on their purchases. To claim a credit for the VAT paid on their tax return, businesses must track and document the VAT they pay on transactions. Tax jurisdictions get tax money along the supply chain, not simply at the point of sale to the final consumer, under a VAT scheme.

What triggers the tax administration requirement?

The following events trigger sales tax obligations:

Taxpayers with a physical presence in a tax jurisdiction or who meet economic nexus standards are examples of nexus.
Prior to the Supreme Court’s decision in South Dakota v. Wayfair in 2018, nexus was determined by a company’s “physical presence” in the state. However, in the post-Wayfair world, if your company sells items in any state — even if you don’t have a physical presence there and the transaction is conducted entirely online — you may be required to register and collect sales tax if you surpass the “economic nexus” level. Sales tax automation software can assist you in determining if you have met the nexus requirement.

The following situations necessitate VAT collection:

Permanent establishment – Having a facility, bookkeeping capabilities, or the ability to enter contracts.
Taxpayers having business activities in a tax jurisdiction that exceed the monetary threshold must register.
A VAT registration duty is sometimes triggered by a specific activity (e.g. legal services)

Who collects and remits sales tax and VAT?

The seller is responsible for collecting sales tax and remitting it to the relevant tax authorities for both sales tax and VAT, while there are some circumstances when the buyer must recognise the tax instead.

Invoicing

Sales tax should be stated separately by the seller.
VAT: For a VAT invoice, the seller should state VAT individually and include a registration number; however, in most VAT jurisdictions, prices are tax inclusive.

Who pays sales tax and VAT?

Only the ultimate purchaser pays sales tax.
VAT: All purchasers pay VAT; nevertheless, the ultimate consumer bears the economic burden of VAT because they do not have the right to deduct input VAT.

Taxability of purchases by business

Sales tax: Resellers give the vendor a tax exemption certificate and do not pay sales tax on things they plan to resell.
VAT: Resellers pay tax to the vendor and are able to reclaim the VAT on business inputs.

Audit risks for sales tax and VAT

Vendors who sell to resellers must retain valid exemption certificates on file, or risk an audit assessment that converts exempt sales to taxable sales.
VAT: In order to get the reclaimed VAT, all parties must preserve invoices for purchases that document the VAT paid.

Revenue timing for tax authorities

Tax income is not received by tax authorities until the end consumer is sold.
VAT: Tax authorities get tax receipts significantly earlier, receiving tax revenue as value is added across the distribution chain.

What should a purchaser do when a vendor does not have a liability to collect tax, or to collect tax on specific items, as stated in tax law?

Calculate the necessary use tax and transmit it to the appropriate tax body.
When it comes to VAT, a buyer should always calculate and declare a reverse charge.

How can Thomson Reuters ONESOURCE help you manage sales tax, VAT, and other indirect taxes?

If you are a corporate tax professional dealing with indirect taxes such as sales tax and VAT, learn how global tax determination software like ONESOURCE Determination can help you get tax right the first time, every time.

Are you unsure about your company’s sales tax obligations? If so, we encourage you to explore our blog for more indirect tax insights: “Does Your Company Have a Multistate Sales Tax Obligation?”