Updated on July 20, 2022
Value-added tax (VAT) and sales tax are two different types of taxes. 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.
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Sales tax vs. VAT overview
When the final sale in the supply chain is made, the merchant collects sales tax. Therefore, the final customer is responsible for paying sales tax on their purchases. Businesses can provide resale certificates to sellers and avoid sales tax when purchasing supplies or materials that will be resold. Sales tax is not collected until the ultimate consumer receives the product, and tax jurisdictions do not earn any revenue from the transaction.
All vendors at every point of the supply chain collect VAT, however. Sales tax is collected by all parties involved in the supply chain. VAT is a mandatory tax for all parties involved in the supply chain, including manufacturers, distributors, retailers, and final 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. It is not simply at the point of sale to the final customer that tax jurisdictions get tax income under VAT.
What triggers the tax administration requirement?
The following events trigger sales tax obligations:
It’s possible to have a physical presence in more than one jurisdiction for the purposes of taxation, which is known as “economic 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. 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.
The following situations need the collection of VAT:
Existence of a facility or the ability to enter contracts as a sign of 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 recognize the tax.
Invoicing
The merchant should include sales tax in the item’s price.
A VAT invoice must include a VAT registration number and a separate VAT statement from the seller, however prices are usually tax-inclusive in most countries that use the VAT system.
Who pays sales tax and VAT?
It is only the end consumer who pays sales tax.
Due to the lack of an input VAT deduction right, the ultimate consumer bears the financial burden of VAT.
Taxability of purchases by business
Retailers do not pay sales tax when they buy goods to resell because they provide a tax exemption certificate to the vendor.
Reclaiming VAT: Resellers recoup the VAT they paid on business inputs from their vendor.
Audit risks for sales tax and VAT
In order to avoid being hit with a tax assessment, vendors who sell to resellers must maintain current exemption certificates on file.
In order to reclaim VAT, all parties must preserve invoices for purchases that show that VAT was paid.
Revenue timing for tax authorities
When a product is sold to a customer, the tax authority does not get any money from that sale.
Due to the value-added tax (VAT), governments are able to collect income significantly earlier on, since tax payments are received along the whole supply 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 and send the necessary usage tax to the appropriate tax authorities.
Reverse charge calculation and reporting is a standard norm for VAT purposes.
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?”
