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Comparing the U.S. Sales Tax to a VAT

author photo of Sylvia F. Dion

Foreign companies that sell to customers in the United States often find that the U.S. system of taxing the sale of goods and services is vastly different from the taxing system of their country. This is especially the situation if the foreign seller is from a country that imposes Value Added Tax (VAT).

Although there are some similarities between the U.S. sales tax and a VAT system, there are many differences. For foreign sellers that are just beginning to sell into the U.S. market, there is much to know. In addition to understanding how U.S. sales taxes are applied, foreign sellers need to be aware of their responsibilities as “tax collection agents”, that a uniform tax rate does not apply across the entire the United States, or that sellers can be subject to severe penalties for not fulfilling their responsibilities.

Yes, there is a lot to know! So in this post, I’ll provide an overview of a few key concepts of the U.S. sales tax system and highlight how the sales tax differs from a VAT. I’ll also provide a chart with some of the key VAT versus sales tax differences.

Revisiting Nexus

In my last "foreign seller” post, I highlighted how the U.S. sales tax system allows each individual State to impose its own rules about what is and what is not taxable and what sales tax rate should apply to a sale transaction. (See Note A below for additional "Sales Tax - By State" details and resources.)

In that post, I also explained the concept of "nexus", which is the "connection" that an out-of-state (or foreign) company or seller must have to a specific State before the State can tax or impose other duties on the company or seller. Having a sufficient “nexus” gives a State the authority to require a seller (including a foreign seller) to collect its sales tax. I also pointed out that having inventory or employing the services of an independent agent in a state, are activities that just about every state would consider to be a sufficient “nexus”. Finally, I also highlighted that even though these same activities might not create a U.S. Permanent Establishment (PE) because States are not bound by bi-lateral treaties that the U.S. Government enters into, a foreign seller can still be subject to the State's tax and requirements even if the seller is not subject to federal taxation.

Key Comparisons Between Sales Tax and VAT

Once a foreign company/seller is found to have nexus to a specific state, the company/seller must comply with the requirements of that state. Therefore, the first thing to highlight in today’s post is that sales tax is not a tax on the seller. When a seller has a sufficient nexus to a state, the seller has a responsibility to collect the tax due on the sale transaction if the purchaser is the final consumer of the product or service. A general rule regarding whether sales tax is due on a transaction is that sales of tangible personal property (TPP) are always taxable unless a specific state exemption applies. (I’ll touch on sales tax exemptions in a minute.) But TPP is more than just goods that can be held or seen. TPP subject to sales tax can include digital goods, such as e-books and digital downloads, or software accessed via the cloud. As a matter of fact, one of the most controversial areas of sales taxation in the U.S. deals with whether and how digital, cloud based, and SaaS products are taxed. But getting back to the basics, one more general rule is that services are generally not subject to tax. A service is only taxed if a State law specifically says that the specific service is taxable.

Therefore, one way that a VAT compares to a sales tax is that a VAT is generally imposed at every stage of production on all “business inputs”. For instance, VAT is charged when raw materials are sold to a manufacturer, again when the manufacturer sells his finished product to a distributor, again when the distributor sells the product to a retailer and once again, when the product is sold to the final consumer. Although to those not familiar with a VAT, it may appear that the tax is collected/paid in full multiple times, this isn’t the case. This is basically because VAT is charged on the gross profit or value added each time the product moves through the supply chain. What this means is that VAT is charged and collected in increments as the products and/or services move to the final consumer. However, sales tax is only charged and collected once – when the goods or taxable services are sold to the final consumer at the total final sale price.

Foreign sellers accustomed to all business inputs being taxed may wonder how it is that tax is not charged at each stage of production. Here is yet one more difference between the U.S. sales tax and VAT system. In general, many of the same business inputs that would be subject to VAT are often exempt from sales tax. This is because many business inputs such as raw materials, components that will integrated into another product, machinery & equipment used in the manufacturing process, and finished inventory purchased for resale, are generally exempt under the various State sales tax laws. This means that a seller is not required to charge and collect sales tax upon the sale of an exempt business input as long as the purchaser provides a valid exemption or resale certificate. The rules on which exemption certificate must be obtained from a purchaser to excuse the seller from charging sales tax are complex. Some states, such as Massachusetts, may have a single form which can be used to claim a variety of different exemptions (click here to see Massachusetts Form ST-12, Exempt Use Certificate. Notice the many business input categories listed on the form.) Other states may have a different form for each type of business input (one form for inventory purchased for resale, a different form for machinery/equipment used in manufacturing, etc.) And some States accept a general Multi-juridictional form. By the way, exemption certificate management is one of the most popular topics on the SalesTaxSupport.com site. (For more information refer to the Exemption Certificate Management Blog, the Exemption Certificate Library or the Sales Tax Questions About Exemptions section.)

So, in conclusion, today I touched on just a couple of ways in which U.S. sales tax differs from VAT. Certainly there are more than just these, but we'll leave those for another post! In addition to the brief overview above, I've also created the following chart which summarizes these main points.

Value Added Tax (VAT) Sales Tax
VAT is an indirect tax charged/collected at each stage of production. Sales tax charged/collected only from the final consumer.
VAT is generally due on all "business inputs" such as raw materials, machinery & equipment, supplies, business services, etc. Sales tax is often not due on "business inputs" because these inputs often qualify for an exemption from sales tax, (e.g., resale, manufacturing, etc.)
Because VAT is collected at each stage of production, the seller generally does not have a responsibility to verify whether the purchaser is another producer or distributor or how the goods or services purchased will be used. The seller is responsible for collecting the sales tax from the purchaser unless the purchaser provides the seller with a valid certificate verifying that the purchase is for resale, or the goods or services purchased qualify for an exemption.
In general, all business inputs, which include business services, are subject to VAT. In general, services are exempt from sales tax unless the state or local jurisdiction lists the specific service as being taxable.
VAT creates an incentive to collect the tax because the government only receives the tax on the gross margin of each transaction. Sellers do not have a direct economic incentive to collect sales tax.

 

Final Thoughts

As I said in my last post “The U.S. sales tax rules are complex even for U.S. based companies – and can be even more confusing for foreign sellers.” And so, this is why I’ll be blogging about many different sales tax topics with a focus on foreign companies/sellers. If you’re a foreign company/seller reading this post and have specific topics in mind, I encourage you to post your suggestions below. Of course, questions and comments are always welcome!

Note: More on State and Local Sales Taxes and Information Resources. Foreign seller should be aware that forty-five (out of our fifty) states, plus the District of Columbia, impose a state level sales tax. The only states which do not impose a state level sales tax are New Hampshire, Oregon, Montana, Alaska and Delaware. This means that in general, foreign sellers do not have to worry about collecting sales tax from purchasers in these five states. But also note that several States allow their local jurisdictions (counties, cities, etc.) to impose a sales tax. This means that in some states, such as California, Texas, Colorado, Louisiana and Arizona, the total sales tax rate that must be charged will vary across the state. You can find information about each U.S. state's sales tax requirements (as well as tax rates) in SalesTaxSupport.com's "Sales Tax - By State" section.

About the Author: Sylvia F. Dion, MPA, CPA, is the Founder and Managing Partner of SALT Consulting firm, PrietoDion Consulting Partners LLC. Sylvia has been covering Internet Sales Tax developments for SalesTaxSupport’s Issues blog since 2011. Sylvia is also the “U.S. Sales Tax for Foreign Sellers” contributor for SalesTaxSupport’s Industry blog and the “Massachusetts Sales Tax” contributor for SalesTaxSupport’s State blog. You can follow Sylvia on twitter and on Google+ and can contact Sylvia via e-mail at sylviadion@prietodiontax.com or at 978-846-1641.

Comments or questions may be submitted by using the on-page "Comment" feature, subject to disclaimer at bottom of page. Other contact options (and Consultation Requests) are also available on Sylvia's associated Firm Profile page.

Other recent “U.S. Sales Tax for Foreign Sellers” posts by Sylvia F. Dion, CPA:

NOTE: All blog content, comments, and participation subject to disclaimer at bottom of page.

Comments

9 Responses to Comparing the U.S. Sales Tax to a VAT

  • Posted by Kevin on January 19, 2017 6:41am:

    Dear

    I am a European, Belgium based company owner and we charge 21% VAT on goods and services. I'm a cinematographer so I mainly charge for my service and rent my equipment that I used.

    If I buy something from my dealer that has a value of 100 EUR, then I will pay 21 EUR VAT on it, If I sell a service to one of my clients for 200 EUR, I will charge him 42 EUR VAT so that makes a total of 242 EUR.

    At the end of every quarter we have to file our accountancy to the government. In my case I have to transfer the collected VAT to the government. So I collected 42 EUR but I payed 21 EUR on the good I bought myself, so I have to transfer the remaining 21 EUR to the government.

    But now I want to start a LLC company in California where there is no VAT system but a Sales Tax of 10%. How does this system works over there. If I buy equipement for that same value of $100 I will pay $10 sales tax myself, but what happens if I make my invoice to a client that includes for example $80 in services and $20 in rental equipment.

  • Posted by Francisco on July 17, 2016 5:41pm:

    Very useful information for those not acquainted with the American tax system.

    • Posted by Author photo of Sylvia F. DionSylvia Dion on July 30, 2016 9:42pm:

      Francisco, Thank you for your kind comment!

  • Posted by Donatella on March 2, 2016 4:34am:

    Dear Sylvia,
    I work in an interior design company based in the UK and we are advising our private client in NY to purchase various furniture items in NY. The client will pay directly the furniture suppliers which will include the payment of the NY Sales tax @ 8.8750% .
    For this service we are requesting a commission to the NY furniture suppliers.
    Do we have to charge NY sale tax for our commission ?
    I could not see this as a sale tax chargeable service, but I am not entirely sure.
    Could you please advice.

    Thank you in advance.

    Kind Regards

    Donatella

    • Posted by Author photo of Sylvia F. DionSylvia Dion on March 22, 2016 6:40pm:

      Donatella,

      Thank you for reading my post and for your comment/question.

      From what you describe, it sounds like you will be charging a commission to the New York furniture suppliers, correct? It does not appear that you are providing an actual service for this commission - which sounds more like a referral fee. As you may know, interior design services are a taxable service in New York (see: https://www.tax.ny.gov/pubs_and_bulls/tg_bulletins/st/quick_reference_guide_for_taxable_and_exempt_property_and_services.htm) therefore, you would want to insure that what is being provided would not be considered to be part of your interior design services. So in general, I would say the commission that you would charge the New York furniture suppliers will not be subject to NY sales tax. I hope this helps.

  • Posted by khan on December 11, 2015 1:55pm:

    Hi Sylvia,
    great article. thank you so much. I live in Canada, and thinking of starting a FBA on amazon.com in USA. I do not have a business entity setup in Canada, and don't think I will have one until I see some profits from selling it on amazon.com.
    I have few questions for you after going through all of your articles for international sellers. kindly reply them when you have time, thanks so much.
    1. At what point (revenue$ amount) I should think about registering for sales tax with 16 different states where FBA has fulfilment centres. I read somewhere $20,000 in revenue? but someone said me to register even if i sell$1 product.
    2. How much money does it cost me to register in all those 16 states specially when I don't live in USA. And how much time it consumes?
    3. Amazon asks me to fill W8-BEN form and apparently it gives me EIN the same day. Do I have to deal with IRS for this or amazon basically handles this?
    4. I asked earlier about how much money should I be earning in revenue to start bothering about sales taxes. just to add, in how many months from start selling I should be worrying about this when I start making $100,000 a year?
    5. In Canada, do I have to have an entity registered like sole or corporation or LLC to continue selling in USA with sales permits? Is there a point that I would need it badly so that I get prepared for it.

    thanks so much for this wonderful article, god bless u & ur family :)

    • Posted by Author photo of Sylvia F. Dionsylviadion on December 15, 2015 7:27am:

      Khan,
      Thank you for reading my post and for your comment.

      You present many questions that cannot be answered in a reply to your comment but which are best answered in a private consultation. However, I will provide a few responses here. First, you should know that the requirement to register to collect sales tax is not based how much you earn in sales – it is based on having a connection to the state which is called “nexus”. If you are using the Amazon FBA system, you will have your inventory in some states and Amazon will be your fulfillment agent. Most of the state sales tax laws say that those two activities create the nexus. I wrote another blog article here at SalesTaxSupport about this topic. Here it is: http://www.salestaxsupport.com/blogs/industry/us-sales-tax-for-foreign-sellers/amazon-fba-international-tax/ So the state sales tax laws require that you register to collect sales tax and file and remit the sales taxes collected. The information you have received that sales must be $20,000 or more to register for sales tax is NOT correct. The other answer I will provide is to your question on whether Amazon will provide you the EIN. Amazon does not provide the EIN – they expect the seller to obtain the EIN and to provide it to Amazon. You must deal with the IRS to obtain the EIN. Here is another blog article I wrote on this topic: http://www.salestaxsupport.com/blogs/industry/us-sales-tax-for-foreign-sellers/international-sellers-registering-sales-tax-us-ein/ I often advise reader to be very careful about the information you are “hearing” – if it is not from a qualified tax advisor, you should make sure it is correct.

  • Posted by Charlie on November 10, 2015 10:29am:

    Bravo, thank you for the explanation.

    Amazon FBA seller from EU

  • Posted by Marvin on October 27, 2015 1:28pm:

    My company has a test that clients take online. One of the clients is located in the EU. Do I need to include New Mexico sales tax on my invoices?

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