In the U.S., businesses are exempt from many taxes throughout the supply chain. However, many countries around the world utilize value-added taxes rather than a standard end-consumer sales tax.
Students who want to pursue a career in international taxation should understand the many differences between the two types of tax.
What is sales tax?
A sales tax is exclusively collected by a retailer during the final sale of a good or service. It is paid by the end consumer. Generally, sales tax is only paid on services that are explicitly enumerated. It is only collected a single time, when the good or service is sold to someone for final use.
However, this does not mean that sellers and manufacturers never pay sales taxes. For example, if a company produces electronic goods, it would not pay sales tax on the components it purchases to construct the goods, but it would pay sales tax on the purchase of safety equipment used by its staff. The equipment is not a direct part of the final product, so it is not exempt.
The following are typically exempt from sales tax:
● Goods purchased for resale
● Components/ingredients purchased to create goods for sale
● Machinery and equipment that is directly used to create goods
● Containers and packaging used to ship goods for sale
In specific cases, a sales tax may be applied to the same item indefinitely. For example, a consumer might pay sales tax on the purchase of a new car. At a later date, when someone else buys the car, he or she may also pay a sales tax on the vehicle. This will continue as many times as the vehicle is sold.
Foreign visitors to the U.S. are often confused when sales tax is not included in the list price of retail goods. Unlike in many European countries, the definition of taxable goods varies from jurisdiction to jurisdiction throughout the U.S. and its territories.
For example, Minnesota, Pennsylvania, New York, Vermont, Massachusetts, and New Jersey do not place sales tax on clothing. The majority of jurisdictions exempt food and drugs from sales tax. Oregon, New Hampshire, Montana, and Delaware do not have a state sales tax at all.
Alaska has no state-level sales tax, but permits local jurisdictions to impose their own regulations. Michigan, Maryland, Kentucky, and Idaho impose state-level taxes, but do not permit localities to impose their own regulations.
When the internet became a significant presence in the economy, it caused a number of challenges for tax authorities. The internet made it possible for consumers to easily and frequently purchase goods from other jurisdictions, causing confusion as to which tax rate was applicable to which goods. In 1992, the Supreme Court case Quill Corp. v. North Dakota determined that states could not collect sales tax on goods sold over the internet, unless the seller had a physical presence in the state. In June 2018, the Supreme Court overturned that decision, citing the fact that it is now much easier for internet-based retailers to determine where buyers are located and therefore collect the correct sales tax.
What is value-added tax?
A value-added tax (VAT) is collected throughout a supply chain. That means suppliers, distributors, manufacturers, and retailers collect tax on all qualifying sales. The U.S. has no value-added tax; it is exclusively a consideration of international commerce. Some countries, such as Canada, refer to VAT as a goods and services tax (GST).
To illustrate how VAT works, consider the production of a personal computer. A components manufacturer buys raw materials from a supplier. Another organization assembles the computer and adds software. A retailer purchases computers in bulk and sells them to individual consumers. At each stage, value is added to the product. VAT covers the value each entity adds to the product, not the total value of the item. Therefore, when the computer company sells products to a retailer, it remits liability for the value added by the component manufacturer.
The above example illustrates an invoice-based VAT method. It is widely used throughout the world. In some countries, such as Japan, another method is utilized. This accounts-based method requires businesses to calculate the value of all sales and then subtract all taxable purchases. VAT is then applied to the difference.
VAT rates vary greatly across the world, as do exemption rules. For reference:
● Germany: VAT 19 percent; duties 5-7 percent.
● United Kingdom: VAT 20 percent; duties 0-15 percent.
● China: VAT 17 percent; duties 0-35 percent.
● Russia: VAT 18 percent; duties 5-20 percent.
● India: VAT 1-15 percent; duties 0-30 percent.
One of the biggest differences between sales tax and VAT is perhaps the requirement of sufficient documentation. In a retail environment, sales tax is established within the local jurisdiction and added automatically. A consumer cannot dispute the tax and can do nothing to change the rate. With VAT, entities must maintain thorough documentation to claim tax credits. The documentation of one entity within a supply chain must match documentation provided by other entities, or the risk of an audit increases. The VAT system imposes a sort of self-regulation, as each entity has an incentive to accurately track its taxes to avoid paying more than it owes or taking on more than its fair share of value. Likewise, VAT exemptions must be well-documented to avoid audits.
Tax professionals who work for organizations doing business in multiple countries will need to understand foreign tax laws, as well as domestic regulations. Students in the Online Master of Science in Taxation program at the D’Amore-McKim School of Business at Northeastern University have the option of enrolling in the taxation of entities track, which features two courses on inbound and outbound international transactions.