VAT vs Sales Tax: Difference Between VAT and US Sales Tax with Examples

VAT and sales tax are indirect taxes levied on the consumption of goods and services. The difference between VAT and sales tax lies in their application, remittance process, and governing jurisdiction. In this blog, we will discuss the key differences between VAT and US sales tax with practical examples to clarify and walk you through the complexities of these entities.

Core Differences Between VAT and US Sales Tax

Taxation Overview: What Is VAT and US Sales Tax?

Value Added Tax (VAT) Overview

Value Added Tax is a tax levied on multiple stages of the value chain. However, to prevent a cascading effect of tax-on-tax, the tax is effectively levied only on the value added at each stage. The tax paid on inputs is credited. However, the final consumer bears the full VAT cost as no credits are available at the end-user level.

Sales Tax Overview

Sales Tax is levied only on the final sale of goods and services to end customers. The sales tax is calculated as a percentage of the purchase price. The sellers collect and remit the sales tax to the respective government authority. In the US, sales tax is levied at a state level and they vary across state and local jurisdictions.

Is there VAT in the US?

No, there is no value-added tax in the US. However, if you are a US business with customers overseas, you need to understand how VAT rules apply. 

Administration: Federal vs State and Local Taxation

VAT’s Centralized Administration

In most countries, VAT is applied at the national/federal level. This provides a centralized administration for VAT for businesses, with uniform rates. 

US Sales Taxes’ Decentralized System

In the US, the sales tax is determined at the state level. Further, within each state, the counties can charge a different local sales tax rate over the base state rate. This creates a decentralized system for sales tax collection. 

Tax Triggers: Nexus vs VAT Registration Thresholds

VAT Registration Thresholds

Businesses must register for VAT when their turnover exceeds a specified threshold. VAT thresholds are straightforward and simple. The threshold limit is usually determined by the past 12 month turnovers.The VAT threshold for a service-only business is USD 41,255, and for a goods-only business is USD 82,510 in the European Union.

Nexus Rules for US Sales Tax

Businesses in the US are obliged to collect sales tax once a sales tax nexus is established. Nexus can be based on physical presence, economic activity, or remote sales with thresholds varying by state.The thresholds for establishing nexus can be the number of transactions and/or revenue.

Earlier, only the physical nexus (presence) rule was applied. However, post South Dakota vs. Wayfair, even remote sellers must collect and remit sales tax if they meet certain transaction or revenue thresholds.

‍

Tax Collection and Remittance: VAT vs Sales Tax

VAT’s Input-Output Mechanism

There are two ways VAT is collected - the credit-invoice method and the subtraction method. The credit-invoice method is widely used in most countries.

• Under the credit-invoice method, businesses are levied VAT at each stage of the production. However, they can obtain credits on the inputs purchased. The VAT is effectively levied on the final sale of goods and services to the end consumer.
• Under the subtraction method, businesses pay VAT on the difference in the value of their sales and their purchases. Japan, for example, adopts this method.

The VAT calculated remains the same under both methods. 

Sales Taxes’ Single-State Collection

In the US, sales tax is levied at the state level. Each business with a sales tax nexus must collect sales tax at an effective rate from the end customers and remit it to the state government or local authorities. The effective rate is the sum of the state sales tax rate and the local sales tax rate. The sales tax collection and remittances are decentralised and reported through sales tax returns.

Specific Scenarios and Challenges

Tax Rates and Calculation: VAT vs Sales Tax with Examples

VAT Rates are Uniform and Predictable

VAT rates are uniform within a country. Countries like Kuwait, Libya and Hong Kong do not have a VAT system. 

Sales Tax Rates are Variable and Complex

The US sales tax system is quite complex. The sales tax rate is determined at the state level. Further, there are variations in local sales tax rates within a state. The effective sales tax rate varies across local jurisdictions. 

For example, Arizona has a state sales tax rate of 5.6%. However, the local sales tax rate is 6.9% in Coconino county and 6.6% in Santa Cruz. The effective sales tax rate is  12.5% in Coconino county and 12.2% in Santa Cruz.

Digital Goods and Services: VAT vs US Sales Tax

VAT Treatment of Digital Goods

The VAT treatment of digital goods varies across countries. Within a country, the VAT treatment of digital goods is uniform and consistent. Some of the VAT treatment include:

• In Singapore, VAT on digital goods are levied when consumed or enjoyed there.
• In the Philippines, VAT is levied when digital goods are consumed there, but the definition of ‘consumed’ is vague and uncertain.
• The VAT Mini One Stop Shop in the EU allows for a uniform taxation on digital goods across the member countries.

The digital goods include software, access to databases, online gaming, music, and website hosting.

US Sales Tax Rules for Digital Goods

The sales tax treatment for digital goods varies across states in the US. Majority of the states tax digital goods such as e-books, digital audio, and movies. Florida and New York are among the states that do not tax digital goods.

Audit Risks and Documentation Requirements

VAT Documentation

A VAT return filed by a business must contain information about output VAT (tax that was charged on the purchaser) and input VAT (deductions made on purchase of inputs). To verify these transactions, the business must maintain the relevant invoices. 

Sales Tax Documentation

A business must register for sales tax once a sales tax nexus is established. After that, the business must file sales tax returns on all sales (whether exempt or taxable) at the stated frequency. In case of exempt sales, the business must maintain a current and valid exemption certificate at the time of sale.

Calculator Comparison: VAT vs Sales Tax

VAT Calculation

Assume the VAT rate is 20%. 

Manufacturer: The manufacturer sells the goods at $100 to the wholesaler. The manufacturer collects $20 (0.2 x $100) as VAT. 

Wholesaler: The wholesaler in turn sells the goods at $150 to the retailer. The wholesaler collects $30 (0.2 x $150). The adjusted VAT at this level is $10 ($30 - $20).

Retailer: The retailer sells the goods to the final customer at $200. The retailer collects $40 (0.2 x $200). The adjusted VAT at this level is $10 ($40 - $30).

The total VAT collected is $40 ($20 + $10 + $10).

US Sales Tax Calculation

Assume Ruby runs a retail business in the state of Arizona. She has a shop in Coconino county and Santa Cruz. She sells a product worth $100. Arizona has a state sales tax rate of 5.6%, and the local sales tax rate in Coconino county and Santa Cruz is 6.9% and 6.6%.

Ruby should collect a sales tax of $12.9 [ (5.6% + 6.9%) x $100] in Coconino county and a sales tax of $ 12.2 [ (5.6% + 6.6%) x $100] in Santa Cruz. 

VAT vs Sales Tax: Which is Better?

For Governments: VAT creates tax revenue at each stage of the supply chain. This creates a steady income source for the government. On the other hand, sales tax creates a revenue for the government only when a final sale of goods and services take place.

For Businesses: VAT is a multi-stage tax, where both businesses deal with both input and output VAT, and have to calculate the adjusted tax credit. This increases the complexity. On the other hand, sales tax is a single-stage tax. This simplifies tax collection for a business in multiple stages of the value chain. The sales tax system in the US is becoming increasingly complex due to newer nexus definitions and local variations in sales tax rates.

Conclusion

Understanding the VAT and sales tax system is crucial to business owners, especially those operating internationally or across multiple states. However, business owners do not have to worry about compliance to different tax regimes and requirements. Sales compliance softwares such as Commenda help with tax automation and ensure timely compliance. Book a free demo with Commenda’s experts to know more!

Citations

• TPAF: VAT. (n.d.). https://www.imf.org/external/np/fad/tpaf/pages/vat.htm
• Cfp, K. D. (2021, June 21). The value-added tax brings in billions for other countries, but the U.S. doesn’t have one. CNBC. https://www.cnbc.com/2021/06/21/this-tax-brings-in-billions-worldwide-why-theres-no-vat-in-the-us.html 
• How would a VAT be collected? (n.d.). Tax Policy Center. https://taxpolicycenter.org/briefing-book/how-would-vat-be-collected
• VAT on digital services/MOSS: What services are covered? - Your Europe. (2022, January 1). Your Europe. https://europa.eu/youreurope/business/taxation/vat/vat-digital-services-moss-scheme/index_en.htm
• TAA 16A-014 Computer software | Florida Sales tax attorney. (n.d.). FloridaSalesTax. https://www.floridasalestax.com/taas/taa-16a-014-computer-software/
• Business NYS Sales tax. (n.d.). https://www.nyc.gov/site/finance/business/business-nys-sales-tax.page#
• Sales Tax Guide | Department of Revenue - Taxation. (n.d.). https://tax.colorado.gov/sales-tax-guide
• VAT returns. (n.d.). Taxation and Customs Union. https://taxation-customs.ec.europa.eu/vat-returns_en

Value-added tax (VAT) rates. (n.d.). https://taxsummaries.pwc.com/quick-charts/value-added-tax-vat-rates

‍

‍