Introduction to sales tax and VAT: what’s the difference?

When it comes to transactional taxes, the United States definitely does things differently. As businesses expand into international markets, understanding these taxation differences is critical to maintaining compliance.

In the United States, sales and use taxes are only charged at the final point of sale—resellers and wholesalers are exempted from payment. The rest of the world, including neighboring nations Canada and Mexico, uses a value-added tax (VAT) instead of an end-user sales tax.

In this series of blogs, we’ll be taking a look at how U.S. and international companies face similar tax challenges, despite these major differences. But before we get into the similarities, this introductory post will give you an overview of the differences.

Under the VAT system, tax is charged at all levels of a transaction. Let’s look at how this difference plays out, using the same item: a loaf of bread costing $1, with a 10% sales tax in the United States or a 10% VAT elsewhere.

With the 10% sales tax, the wheat farmer, baker, and supermarket pay no transactional tax on the wheat, instead supplying a reseller exemption certificate. Then, when a consumer buys the loaf at the counter, he or she pays $1 plus 10 cents of sales tax.

Under a 10% VAT, the transaction looks quite different: the farmer sells the baker wheat for 20 cents, and the baker must pay $1.02, including 2 cents in VAT, to the farmer, who will remit the tax to the government. Then, when the baker sells the bread to a supermarket for 50 cents, the supermarket will pay the baker $1.05, including 5 cents in VAT.

The baker will remit 3 cents to the government and take 2 cents back as a refund for the VAT already paid to the farmer. Then, at the supermarket, the consumer pays $1.10 for the loaf, including 10 cents of VAT. The supermarket sends 5 cents to the government, and obtains a refund for the 5 cents it paid in VAT to the baker.

In both cases, 10 cents of tax is paid on each dollar, but it’s plain to see that filing and remitting looks drastically different. Despite these differences, many of the challenges of calculating, filing, and remitting transactional tax remain very much the same.

In our upcoming blogs in this series, we’ll look at how tax challenges in the U.S. resemble challenges being faced by companies all over the world. Avalara’s end-to-end sales tax compliance solutions include not only every jurisdiction in the United States but also nearly 140 countries with VAT collection requirements. No matter where your business expands, we’ll be there for you. Click here to learn more about how Avalara’s VAT integrations can help your business navigate international expansion.