What exactly is the distinction between sales tax and value-added tax (VAT)? Both sales tax and VAT are indirect taxes, meaning that they are collected by the seller, who charges the buyer at the time of purchase and then pays or remits the tax to the government on the buyer's behalf. Sales tax and VAT are frequently used interchangeably in the corporate tax community. To elaborate, consider the similarities and differences between these two types of indirect taxes.
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Overview of sales tax vs. VAT
When the final sale in the supply chain occurs, the retailer collects sales tax. In other words, when end users buy goods or services, they must pay sales tax. Businesses that buy supplies or materials to resell can issue resale certificates to sellers and are not subject to sales tax. Sales tax is not collected until the sale is made to the final consumer, and tax jurisdictions do not receive tax revenue until the sale is made to the final consumer.
VAT, on the other hand, is collected at each stage of the supply chain by all sellers. VAT is collected on taxable sales by suppliers, manufacturers, distributors, and retailers. Similarly, VAT is paid on purchases made by suppliers, manufacturers, distributors, retailers, and end users. Businesses must track and document the VAT they pay on purchases in order to receive a VAT credit on their tax return. Tax jurisdictions receive tax revenue throughout the supply chain, not just at the point of sale to the final consumer, under a VAT regime.
What is the impetus for the tax administration requirement?
Sales tax obligations are triggered by the following events:
Taxpayers with a physical presence in a tax jurisdiction or who meet economic nexus thresholds are examples of nexus.
Prior to the 2018 Supreme Court decision in South Dakota v. Wayfair, nexus was determined by a company's "physical presence" in the state. However, in a post-Wayfair world, if your company sells goods 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 exceed the "economic nexus" threshold. Sales tax automation software can assist you in understanding and determining whether or not you have met the nexus threshold.
VAT collection is required in the following situations:
Permanent establishment – The presence of a facility, bookkeeping services, or the ability to enter into contracts.
Registration threshold – Taxpayers who have business activities in a tax jurisdiction that exceed the monetary threshold.
A VAT registration obligation is sometimes triggered by a specific activity (e.g. legal services)
Who is in charge of collecting and remitting sales tax and VAT?
For both sales tax and VAT, the seller is responsible for collecting the tax and remitting it to the appropriate tax authority, though in some cases, the buyer is required to recognise the tax instead.
Invoicing
Taxes on sales: The seller must separately declare sales tax.
VAT: For a VAT invoice, the seller must separately state VAT and include a registration number; however, in most VAT jurisdictions, prices are tax inclusive.
Who is responsible for paying sales tax and VAT?
Taxes on sales: Only the final consumer is responsible for payment.
VAT: VAT is paid by all purchasers; however, the economic burden of VAT falls on the final consumer because they do not have the right to deduct input VAT.
Purchases made by a business are taxable.
Taxes on sales: Resellers provide the vendor with a tax exemption certificate and do not pay tax on purchases of resale items.
VAT: Resellers pay tax to the vendor and then reclaim the VAT paid on business inputs.
Sales tax and VAT audit risks
Sales tax: Vendors who sell to resellers must keep valid exemption certificates on file or risk having exempt sales converted to taxable sales during an audit.
VAT: To receive the reclaimed VAT, all parties must keep invoices for purchases that document the VAT paid.
Tax authorities' revenue timing
Taxes on sales: Tax revenue is not received by tax authorities until the sale to the final consumer.
VAT: Tax authorities receive tax receipts much earlier, receiving tax revenue as value is added throughout the distribution chain.
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