It’s not unusual for businesses today to have operations in multiple countries – in fact, it’s quite common. And for tax professionals in one of these businesses who are only fluent in the ways of U.S. sales tax, this is where things can get very tricky. Because the way that sales tax works in the United States is very different from how Value Added Tax – or VAT, for short – works. Let’s look at some of the key ways in which Value Added Tax differs from sales tax.
The differences between sales tax and VAT are wide-ranging. To start, at the most basic level, sales tax and VAT are applied in different ways. In the U.S., sales tax is collected on retail sales at the time of the sale to the final consumer, and only the final sale in the supply chain is subject to sales tax. Value Added Tax, on the other hand, is collected at each stage of the supply chain and ultimately charged in full to the final purchaser. Although tax is collected at each stage, a credit is allowed for the tax paid on the inputs for businesses – an Input Tax Credit. Thus, tax is only really remitted on the value added at each stage. And the credits are allowed for tax paid on all business inputs – not just raw materials incorporated into the product sold like under the resale exemption.
When getting acquainted with how VAT works, you need to be literate in the different terminology that is used in the VAT system. Here’s a good example: In the United States, we have nexus, a concept that you are likely aware of. But countries with a VAT structure have a term called “permanent establishment.”
Permanent establishment is a fixed place of business that is permanent enough to give rise to VAT liability within a jurisdiction. In the U.S., there can be differing views on what creates sales tax nexus in a state, but permanent establishment for the purposes of VAT is a factual inquiry. Understanding and using the right VAT terminology is critical if your business operates globally.
Registration requirements for sellers are another area where VAT can be very different if you’re only fluent in sales tax. In the U.S., a seller is required to register to collect and remit sales tax once they have created nexus within a state. However, in many VAT jurisdictions, a supplier is required to register to collect and remit VAT when they exceed a certain threshold. These thresholds can and do vary from country to country. And they can differ based on the nature of the items sold as well as whether the sales are to other businesses or to individual consumers.
Compliance is one more area in where VAT can trip you up if you’ve only worked with sales tax. In the U.S., sales tax compliance is relatively straightforward: registered taxpayers must collect and remit sales tax on state specific returns which can vary. Some are very detailed and some are simpler to complete. Returns must be filed in any jurisdiction where tax is collected. In VAT countries, the compliance requirements can vary widely between jurisdictions. Some jurisdictions have simple VAT returns that only require information about the total VAT collected and paid. Other jurisdictions require detailed breakdowns by rate and type of transaction. And in many countries they must be filed in the local language. All VAT remittance is required to be in the country specific currency.
Just because you’re fluent in sales tax law and terminology, that knowledge won’t get you very far when dealing with VAT in other countries. VAT is a completely different type of system, with different terminology and rules. There can be a steep learning curve when it comes to understanding the terminology and intricacies of VAT. And with VAT rates as high as 27% you need to ensure that you understand how it works so you don’t make any costly mistakes. You don’t want to try and figure out VAT on your own.