Updated on May 15, 2022
When comparing sales tax and value-added tax, what should you look for? Taxes collected by the seller, who charges the buyer at the moment of purchase and then pays or remits tax to the government on behalf of the buyer, are both examples of indirect taxes — taxes that are collected by the seller. In the world of corporate taxation, the terms sales tax and value-added tax (VAT) sometimes lead to misunderstandings. Here, we’ll compare and contrast these two sorts of indirect taxes to see how they differ.
Sales tax vs. VAT overview
When the final sale in the supply chain is made, the merchant collects sales tax. In other words, when you buy something, you have to pay sales tax. Businesses can give resale certificates to sellers when purchasing supplies or materials that will be resold and are not responsible for sales tax. Sales tax is not collected until the product is sold to the ultimate customer, and tax jurisdictions do not receive any money from the sale.
When it comes to VAT, on the other hand, all sellers at every point of the supply chain are responsible for collecting it. All taxable sales are collected by suppliers, manufacturers, distributors, and retailers. VAT is paid by all parties involved in the supply chain: suppliers, manufacturers, distributors, retailers, and end consumers. To claim a VAT refund on their tax return, companies must keep meticulous records of the VAT they pay on their transactions. Every step of the supply chain, not only the moment of sale to the final customer, is taxed under a VAT system.
What triggers the tax administration requirement?
Obligations with respect to sales tax are triggered by
Taxpayers who have a physical presence in a tax jurisdiction or who meet economic nexus standards are considered to have nexus.
Nexus was formerly determined by a company’s “physical presence” in the state before to the Supreme Court’s 2018 South Dakota v. Wayfair decision. Since there is no physical presence or transaction in the state where you sell goods, the “economic nexus” threshold has been established and you may now be required to register and collect sales tax in that state if you exceed it, even if you don’t have any physical presence there and the transaction is conducted online only. Automation software can assist you understand and assess whether or not you’ve met the threshold for sales tax residency.
Following are examples of situations in which VAT collection is necessary:
A location, bookkeeping capabilities, or the ability to enter contracts constitute a permanent establishment.
Taxpayers whose business activities exceed the jurisdiction’s monetary threshold are required to register for tax purposes.
Depending on the nature of the activity, it may be necessary to register for VAT (e.g. legal services)
Who collects and remits sales tax and VAT?
When it comes to collecting sales tax or VAT, the seller is responsible for doing so, however there are exceptions when the buyer is required to recognise the tax.
A separate sales tax declaration should be made by the vendor.
However, in most VAT jurisdictions, the price is inclusive of tax, and the seller should include a VAT registration number on the invoice.
Who pays sales tax and VAT?
Only the final purchaser is responsible for sales tax.
VAT: All purchasers pay VAT; nevertheless, the end consumer bears the economic burden of VAT because they are unable to subtract input VAT from their final bill.
Taxability of purchases by business
- Sales tax: Resellers issue a tax exemption certificate to the vendor and do not pay tax on purchases of items to be resold.
Reclaiming VAT: Resellers recoup the VAT they paid on business inputs from their vendor.
Audit risks for sales tax and VAT
Exemption certificates must be kept on file by vendors that sell to resellers or face an audit assessment that converts exempt sales into taxable ones.
It is imperative that all parties preserve invoices for purchases that show that VAT has been paid in order to reclaim the VAT.
Revenue timing for tax authorities
There is no tax money for the government until the final consumer has paid for a product or service.
It is easier for the government to collect taxes since the value of goods and services is added along the supply chain, rather than only at the point of sale.
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?
The necessary usage tax should be calculated and sent to the proper authority.
Reverse charge calculation and reporting should be done by the purchaser wherever possible, as a general rule.
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?”