A very common question in the tax community is “What is the difference between sales tax and VAT?” To answer this question, let’s outline some of the similarities and differences.
Sales Tax vs. VAT overview
Sales tax is collected by the retailer when the final sale in the supply chain is reached via a sale to the end consumer. End consumers pay the sales tax on their purchases. Businesses issue resale certificates to their sellers when buying business supplies/inputs that will be resold since sales tax is not due. Tax jurisdictions do not receive the tax revenue until the sale is made to the final consumer.
VAT (Value-Added Tax) is collected by all sellers in each stage of the supply chain. Suppliers, manufacturers, distributors and retailers all collect the value added tax on taxable sales. Suppliers, manufacturers, distributors, retailers and end consumers all pay the VAT on their purchases. Businesses must track and document the VAT they pay on purchases in order to receive a credit for the VAT paid on their tax return. Tax jurisdictions receive the tax revenue throughout the entire supply chain as opposed to at the sale to the final consumer chain.
What triggers the tax administration requirement?
- Sales tax:
- Nexus – Taxpayers with a physical presence in a tax jurisdiction or who meet the economic nexus thresholds. With the 2018 outcome of the South Dakota v. Wayfair, Inc. case, economic nexus became very prevalent and taxpayers must be diligent in determining if they meet the thresholds on a continual basis.
- Permanent Establishment – Existence of a facility, bookkeeping facilities or ability to enter contracts.
- Registration Threshold – Taxpayers with business activities that exceed the monetary threshold in a tax jurisdiction.
- Sometimes a specific activity triggers a VAT registration obligation (e.g. legal services)
Who collects and remits the tax?
For both sales tax and VAT, the seller is responsible for collecting the tax and remitting to the appropriate tax authority though there are cases where the buyer must recognize the tax instead.
- Sales tax: The seller should separately state sales tax.
- VAT: The seller should separately state VAT and include registration number for a VAT invoice, however, in most VAT jurisdictions prices are tax inclusive.
Who pays the tax?
- Sales tax: The final consumer.
- VAT: All purchasers however the economic burden of VAT is on the final consumer as they do not have the right to deduct input VAT.
Taxability of purchases by business
- Sales tax: Resellers issue an exemption certificate to the vendor and do not pay tax on purchases of items to be resold.
- VAT: Resellers pay tax to the vendor and reclaim the VAT for the tax amount paid on business inputs.
Audit sticking points
- Sales tax: Vendors that sell to resellers must keep valid exemption certificates on file or risk audit assessment turning exempt sales into taxable sales.
- VAT: All parties must keep invoices for purchases documenting VAT paid in order to get the reclaimed VAT. Review of transactions where zero or reduced rate VAT was paid and the reasons for this.
Revenue timing for tax authorities
- Sales tax: Tax authorities do not get tax revenue until the sale to the final consumer.
- VAT: Tax authorities receive tax receipts earlier, getting them along the entire distribution chain as value is added.
What should a purchaser do when a vendor does not have a liability to collect tax, or on specific items as stated in tax law?
- Sales tax: Calculate and remit the appropriate use tax to the appropriate tax authority.
- VAT: As a general rule a purchaser should calculate and report a reverse charge when necessary.
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