E-commerce tax essentials: a guide to VAT vs sales tax for sellers 

Navigating through the world of taxes can feel like diving into a maze, and the terms VAT (Value Added Tax) and sales tax often add to the confusion. 

They’re both types of indirect taxes used by governments in many countries. And with the global e-commerce market set to hit a staggering $8.1 trillion by 2024, it’s really important to understand the differences between these two taxes if global expansion is your ultimate business goal. This knowledge is crucial for financial planning, staying compliant, and getting insights into consumer behaviour. 

This handy guide will break down the two taxes, what you need to know about them and the major differences between them that you need to look out for. So, let’s dive in and unravel the mysteries of VAT versus sales tax! 

What is VAT? 

VAT, also known as Value Added Tax, is a type of consumption tax that applies to both digital and physical goods or services. Instead of just being added at the point of sale, VAT is actually added at every step of the production and distribution process. 

So, let’s say you’re buying a shirt. The manufacturer adds VAT when they make the shirt, then the distributor adds VAT when they sell it to the retailer, and finally, the retailer adds VAT when they sell it to you. Each time the value of the product increases, VAT is added. VAT may still be applied if the product value decreases. 

Businesses have an important role in this system. They are responsible for collecting VAT from customers and then passing it on to the government. It’s not always an easy task, but it’s necessary to ensure that the government gets its fair share. 

This tax system is commonly used in many countries and may be referred to by different name. In some countries, it’s called Goods and Services Tax (GST). So, if you ever come across that term, don’t be confused. It’s the same concept, just a different name. 

So, whether you’re buying a physical item or a digital service, keep in mind that VAT might be included in the price. It’s just a way for the government to get a piece of the action and fund public services. 

How does VAT work? In simple terms 

VAT is a tax that gets added at every stage of making or selling something.  

Let’s break it down: a manufacturer buys raw materials and pays VAT. Then, they jazz up those materials in the production process, increasing the selling price. At every buying and selling step, there’s VAT, calculated based on the added value. 

Businesses can balance things out by subtracting the VAT they paid on materials from the VAT they collected on sales. This helps them reach a “tax-neutral” position – it’s like a balancing act. 

It’s important to know that different countries have different VAT rates and thresholds. For example, the United Kingdom has a standard VAT rate of 20%. But in some countries like Switzerland, the rate is lower. And in certain cases, jurisdictions might have reduced or even exempt rates for specific goods and services. 

Why are there these variations, you may wonder? Well, it all depends on each country’s goals, economic conditions, and social considerations. They have their reasons for setting the rates the way they do. It’s all part of the bigger picture. 

The advantages and disadvantages of VAT 

VAT comes with its perks. First of all, it brings in a lot of cash for governments because it covers so many different things and gets more expensive as you spend more. But it’s not just the government that benefits – businesses can also claim input tax credits, which basically means they can subtract the VAT they already paid on their inputs. So they end up paying less tax overall. 

However, VAT also presents challenges. Businesses have to deal with a lot of paperwork and make sure they calculate and report their VAT correctly.  

Plus, they need to watch out for potential tax fraud or evasion, so not exactly a walk in the park. 

Exploring sales tax 

Sales tax is different from VAT. It’s a type of tax applied in the US on goods and services at the point of sale. It’s the tax you pay when you buy something as a consumer. 

When you see a price tag the sales tax would be added on at the till when you make the purchase; it’s the retailer’s job to collect then pay the tax. 

The rates of sales tax can differ across various states. 

How is sales tax collected? 

When you buy something, like goods or some services (depending on the state), sales tax is collected. The tax is added to the total cost of your purchase, and the seller is responsible for collecting and remitting the tax to the government.  The percentage of sales tax can differ depending on where you are.

To give you an example, let’s say you’re buying a laptop from an electronics store. The retailer would add on the sales tax percentage in the selling price, and collect the money when you pay. Then, like a responsible citizen, they forward it over to the tax authority that’s in charge. 

This whole process is put in place to ensure everyone follows the tax laws and regulations. It’s important for sellers to accurately calculate and keep track of the sales tax they’ve collected. Otherwise, they could face some serious consequences like penalties, fines, and harm to their reputation. 

What is sales tax nexus? 

Sales tax nexus refers to the connection or presence that triggers a business’ obligation to collect and remit sales tax in a particular state. It’s like an official signal that says “Hey, you need to start collecting sales tax here”. 

Every state has its own rates and thresholds for determining economic and physical nexus. The rates may be the same across the whole area, or they may vary depending on what’s being sold. Some states may also have specific thresholds that determine whether you have to collect sales tax or not.  

For brick-and-mortar stores, it’s usually pretty straightforward. If you have a physical presence in a state, like a store or warehouse, then you’ve got nexus there. But e-commerce sellers face a more complex landscape, as sales tax nexus can be established through other factors – like hitting certain sales thresholds or doing online transactions in a specific state. 

This concept is important because once your business has nexus in a state, you’ve got to start collecting and remitting sales tax on all the transactions that happen in that jurisdiction. This is to ensure you comply with tax regulations and avoid penalties. So, keep an eye out! 

How VAT and sales tax impact businesses and consumers

VAT affects businesses at different stages of production and distribution, creating more administrative work and cash flow challenges. However, businesses can claim input tax credits to reduce their overall tax liability. 

Sales tax mainly affects consumers by increasing the price customers pay when they purchase. This can influence consumer behaviour and purchasing decisions, with higher sales tax rates potentially discouraging spending. 

Knowing these differences is important for businesses and consumers, as it helps them understand how VAT and sales tax impact the economy. 

International tax perspectives on VAT and sales tax 

The way countries handle Value Added Tax (VAT) and sales tax varies worldwide, impacting economies and consumer behaviour differently. Understanding these global approaches provides insights into the effectiveness of taxation systems. 

European and UK VAT dominance in revenue generation 

Many countries, such as the United Kingdom, Germany, France, Australia, and Canada, heavily rely on VAT as a primary revenue source. These nations have fine-tuned their VAT systems over time, adapting them to specific economic, social, and political contexts. This evolution reflects the ongoing effort to optimise revenue collection. 

The US: primarily sales tax 

Meanwhile, the US predominantly relies on sales tax for revenue.  

However, it’s important to note that sales tax governance in the U.S. operates at the state level, leading to variations in rates, thresholds, and exemptions across different states and local jurisdictions. States like Alaska, Delaware, Montana, New Hampshire, and Oregon stand out as exceptions, not imposing state-level sales tax.  

These variations highlight the diverse economic and political landscape within the US. 

Economic implications: VAT vs. sales sax 

When comparing countries that employ VAT and sales tax systems, it becomes clear that these systems have significant economic implications. 

VAT, with its ability to capture tax revenue at multiple production stages, serves as a stable and diversified income source for governments. It offers potential benefits for businesses through input tax credits and enhances transparency in the supply chain.  

Sales tax systems often boast simpler administration and collection processes, particularly in states with fewer jurisdictions and exemptions. 

How can AVASK help with VAT and sales tax? 

Understanding the complexities of VAT and sales tax can be overwhelming, especially for businesses that operate in multiple countries or states. If you’re looking to expand your business into the US, or into the UK and Europe, here’s where AVASK steps in to provide invaluable assistance:

• We specialise in aiding sellers with VAT and sales tax registration, ensuring businesses are set up correctly and compliant from the start 

• Our team of experts is dedicated to assisting sellers in streamlining the filing and returns process, ensuring a hassle-free and accurate experience 

• With AVASK, staying compliant is a priority – we ensure that your tax calculations are always aligned with the latest legislation 

VAT and sales tax: frequently asked questions