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5 Min. Read

Sales Tax Vs VAT: What’s the Difference?

Sales Tax Vs VAT: What's the Difference?

Sales tax and value-added tax are types of indirect tax. To compare, let’s outline the definitions, similarities, and differences between sales tax and VAT.

Sales taxes are imposed by state governments on retail purchases of goods or services that are not exempt from taxation. A value-added tax (VAT) is a type of consumption tax assessed on goods at each stage in the production process as they move through it to their final sale to consumers. Let’s take a closer look at how these two types of indirect taxes work so you can understand them better!

Here’s What We’ll Cover:

What is VAT?

What is Sales Tax?

Are VAT and Sales Tax the Same?

Who pays VAT: Seller or Buyer?

Audit Risks for Sales Tax and VAT

Key Takeaways

What is VAT?

A VAT is assessed on goods at every stage of the production process, even though it may be collected in one lump sum from the producer. A company can recover any VAT it has paid for its own purchases by charging customers a similar amount when they buy goods or services, so ultimately the tax is not really collected multiple times. For this reason, a VAT is really a tax on consumption.

What are the Three Main Advantages of a VAT?

Some important advantages of a VAT are:

  • It doesn’t tax the customer
  • It is harder to evade than other types of indirect taxes
  • It incentivizes governments to have lower sales tax rates.

What is an Example of VAT?

Here is an example of VAT:

A food producer makes $500,000 selling its goods. The VAT standard rate is 20% (hypothetical standard rate), so the tax amount collected by the government will be $100,000. If this company uses only one stage of production (for example, organic farming), then it can recover all of this VAT cost by charging purchasers an equal amount. With the VAT, there is no need for an intermediary to collect money from either party.

What is Sales Tax?

Retail sales tax are imposed by state governments. The rate of taxation for each product varies depending on where it was sold. A consumer can usually recover any sales tax he or she has paid when buying certain items (for example, if you’re getting your car repaired, sales tax you’ve paid on parts can be deducted from your bill). Every state has a different sales tax rate, and the range of rates is large. No matter what, this sales tax burden is paid by the final customer. Individual income does not affect sales tax.

Are VAT and Sales Tax the Same?

VAT rates and sales tax are different because they are assessed at different points in the production process. VAT is paid on purchases by manufacturers, wholesalers, and retailers, so it’s ultimately not recovered by consumers. Sales tax is only paid by the consumer. A sale of a product at retail would include both sales tax and VAT, while a sale of an item to another business would not have sales tax because the business is not a consumer.

VATs are slightly different in that they can be applied at each production chain stage, while sales taxes are only paid once when the final product is sold to consumers. As such, most governments prefer collecting VAT over sales tax because it is more revenue-efficient.

Would a VAT Tax Replace Sales Tax?

The US federal government has assessed a value-added tax on exports and, in certain cases, on the purchase of imported goods. That means that any VAT within the US would be imposed primarily at the state level. If you want to abolish sales tax altogether, perhaps a nationwide VAT could replace it. That would drastically raise prices for American shoppers, so this is not likely to happen anytime soon.

Who pays VAT: Seller or Buyer?

Sales tax is collected by the seller. It can be passed on to the buyer, but it’s not mandatory that they do so.

Audit Risks for Sales Tax and VAT

Businesses must file sales tax returns and VAT returns according to laws imposed by the federal government. If mistakes are made, or if a company owes money in taxes that it hasn’t paid, then an audit will be performed. This can result in fines from the government, but it may also be expensive for a business to spend time and money dealing with the audit.

Key Takeaways

Both are used by the government to collect tax revenue. The key differences between VAT and sales taxes are as follows. VAT is imposed on businesses at every stage of production. A sales tax is paid by the consumer. Some items are exempt from sales tax. A VAT can be recovered by any business selling its own products. Sales tax can only be recovered by certain businesses. VAT is levied at a single rate. It gets added to the price of goods and services throughout the production process. Sales tax is imposed by state governments and rates vary from state to state. Hopefully this answers any questions you have about VAT vs sales tax.

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