Both Sales Tax and Value Added Tax (VAT) can present a number of challenges to tax practitioners who are well versed in one, but not the other. To begin, the basic structures of how sales tax and VAT are imposed are largely different. But once you delve a little further into each one, you may notice that the terminology used looks foreign and unfamiliar. Sales tax and VAT have different terms for essentially similar concepts, but sometimes the concepts themselves are handled altogether differently. We’ll take a look at some of the language and terms used in sales tax and VAT, how they’re similar and what makes them different.
Nexus vs. Permanent Establishment
In the U.S., nexus is the basic concept of whether a company has sufficient presence in a state which then requires them to collect sales or use tax. Nexus refers to links, connections, or contacts between a political jurisdiction and a taxpayer. If a taxpayer has sufficient nexus with a state, it is deemed to be “doing business” in that state and will be liable for the state taxes. In VAT countries, a permanent establishment for VAT purposes is a factual inquiry. It could include: having a facility located in the country, bookkeeping facilities located in the country, and the ability to enter into contracts. How these differ is that the U.S. sales tax has moved towards temporary physical presence and even less than physical presence activities. In the VAT countries, it is more reliant on a permanent establishment of the business in the country. Of course, some things are changing, particularly for businesses that sell digital goods. But more often than not, if a company doesn’t have a permanent physical location in a VAT country, they typically don’t have to collect the VAT. But this is less likely under the U.S. sales tax.
Resale vs. Input Tax Credit
In the United States, we have sales for resale: if you purchase items that you intend to resell prior to making any significant use of it, there is no sales tax due on your purchase. In VAT countries, since tax is imposed on each stage in the transaction, there is no concept of resale or an exemption on inventory. Rather, in a VAT tax regime, an input tax credit is allowed for the tax paid on all business inputs – inventory PLUS operating expenses and capital purchases. The input tax credit is used to reduce the business’s overall tax liability since the net result is a business that is subject to VAT is able to claim a credit for the tax it has paid.
Use Tax vs. Reverse Charge
In the U.S., use tax acts as a complement to the sales tax. While sales tax is assessed upon the retail sale of tangible personal property (TPP), the use tax is generally assessed upon the storage, use, or consumption of TPP purchased at retail and upon which no sales tax was paid. This is more of a voluntary compliance process and there is significant leakage when customers (predominately individual purchases) don’t pay the tax to the seller and don’t self-assess the use tax. In VAT countries, in a reverse charge, the supplier no longer collects that tax and the requirement to collect and remit the tax shifts to the purchaser when the purchaser is a VAT registered business. In addition, in a VAT country, imports are taxed at the border so as goods are purchased from abroad, there is no leakage of the tax. In the US, there is no border (either country or state level) enforcement. Therefore, the voluntary use tax is the only method for the imposition and remittance of tax for goods or services purchased from an unregistered remote seller.
These are some of the different terms and concepts that are used in sales tax and VAT structures. To learn more about these and other issues related to VAT vs. Sales Tax, the Sales Tax Institute will be presenting the “VAT vs. Sales Tax: What are the Differences and How do they Work?” Webinar on September 12, co-presented by Thomson Reuters. The Webinar will be presented by Bernadette Sablan and Anil Kuruvilla of Thomson Reuters and Diane Yetter of the Sales Tax Institute. For more details, please click here.