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.
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.|
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.
Other recent “U.S. Sales Tax for Foreign Sellers” posts by Sylvia F. Dion, CPA:
- Wayfair & Economic Nexus for Foreign Sellers: Key Sales Tax Questions
- U.S. Sales Taxes: Filing Frequency for International Sellers
- 7 Key Points Foreign Sellers Should Know about U.S. State Taxes
- Do International Sellers Registering for Sales Tax Need a U.S. EIN?
- International Sellers and U.S. Sales Tax Registration: 3 Key Issues