What is the difference between sales tax and VAT?

Updated on May 23, 2022

Are there any similarities or differences between the sales tax and VAT? Indirect taxes, such as sales tax and VAT, are levied on the buyer by the seller, who then remits the money to the government on the buyer’s behalf. In the world of corporate taxation, the terms sales tax and value-added tax (VAT) sometimes lead to misunderstandings. As an example, let’s contrast these two sorts of indirect taxes to see how they compare and contrast.

Sales tax vs. VAT overview

The store collects sales tax at the end of the supply chain. In other words, when you buy something, you have to pay sales tax. Businesses don’t have to pay sales tax on purchases of products or materials that will be resold. Resale certificates can be issued to sellers. Sales tax is not collected until the ultimate consumer receives the product, and tax jurisdictions do not receive any revenue from the sale.

In contrast, all vendors at every point of the supply chain are required to collect VAT. 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. In order for businesses to claim a tax credit for VAT paid on purchases, they must keep track of and document the VAT they pay. 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

A nexus, for example a physical presence in a tax jurisdiction or meeting the economic nexus standards, is required for a taxpayer to be taxed.
A company’s “physical presence” in a state was all that was required for nexus prior to the 2018 South Dakota v. Wayfair Supreme Court decision. Now that Wayfair has been decided, you may have to register and collect sales tax in each state where your business sells goods, even if you don’t have a physical presence there and the transaction is purely online. Using a sales tax automation software can assist you comprehend the nexus threshold and evaluate if you have met it.

Tax collection is essential in certain situations:

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.

Invoicing

The merchant should include sales tax in the item’s price.
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 ultimate consumer 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

Resellers get a tax exemption certificate from the vendor and don’t have to pay sales tax on purchases for resale.
For the VAT they pay on business inputs, resellers recoup the tax they pay on those inputs.

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.
In order to reclaim VAT, all parties must preserve invoices for purchases that show that VAT was paid.

Revenue timing for tax authorities

Sales tax: Tax authorities do not receive tax money until the sale to the final customer.
As value is added to the supply chain, the tax authorities are able to collect tax income considerably earlier.

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?

Remit usage tax to the proper tax authority.
When a reverse charge is required, the buyer should calculate it and notify it to the government.

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

Learn how ONESOURCE Determination, a global tax determination software, can help you get tax right the first time, every time you deal with indirect taxes like sales tax and VAT.

Your company’s sales tax requirements may be a source of confusion for you. So, if you’re interested in learning more about indirect taxes, check out our blog: “Is Your Company Required to Pay Sales Tax in More than One State?”