What is indirect tax? A practical guide for small businesses

If you sell online, you’ll likely encounter indirect taxes at some point. Indirect taxes can apply to any kind of business, whether you’re building a SaaS app, shipping handmade rugs, or teaching yoga classes on Zoom.

These taxes appear on every checkout screen, invoice, and customs form, and getting them wrong can result in significant penalties with tax authorities.

In this guide, we’ll explore:

• the difference between direct and indirect tax
• the most common indirect tax examples
• and the practical steps you need to stay on the right side of the law (and your customers).

By the end, you’ll understand how to handle indirect tax compliance.

Indirect tax definition

An indirect tax is any levy your business collects from the end customer and then passes on to the relevant government authority. In other words, the tax burden shifts through a chain. Consumers pay it, businesses collect it, and governments pocket it as a source of revenue.

Indirect tax examples include sales tax on a morning latte, value-added tax (VAT) on an e-book download, and excise taxes on fuel. More information on these examples soon!

Understanding the definition of indirect tax is essential when exploring small business ideas. These policies impact pricing, profitability, and your business operations when it comes to indirect tax compliance. From VAT to sales tax, knowing how they work helps entrepreneurs make informed financial decisions and avoid unexpected costs.

Note: VAT, sales tax, and Goods and Services Tax (GST) are a subset of indirect taxes also known as “consumption taxes”. Unlike income or payroll taxes, you don’t feel the hit when filing your tax return – the customer feels it at the point of purchase, as they’re the ones “consuming” the product.

Direct Tax vs. Indirect Tax

At a glance, indirect and direct taxes contribute to the government's revenue. But they flow through your business in different ways.

Here are a few differences between direct and indirect taxes.

Who feels the pinch

With indirect taxes, the tax burden is hidden in the price tag. Your customer pays an extra couple of dollars for their product. You collect that money at checkout and then remit it to the tax authorities. It’s a consumption tax (as we’ve discussed above), so the more you buy, the more tax you pay.

Who writes the check

Direct taxes are about federal income taxes, payroll taxes, and business property taxes. These come straight out of the taxpayer’s pocket. There’s no passing them along in the supply chain. You (or your employee) send the funds directly to the government.

How visible they are

Indirect taxes may feel “invisible” until you look at the receipt. Direct taxes, however, are typically presented as quarterly estimates or an annual bill.

Compliance effort

With indirect tax compliance, you’re tracking the changing tax rates across states (and country to country, if you’re selling internationally) and filing multiple returns. As for direct taxes, there are fewer jurisdictions involved, but these require more detailed record-keeping of profits, payroll, and assets.

Differences between direct vs. indirect tax

Common types of indirect taxes

Imagine you’re a freelance illustrator in Austin selling printed posters and digital downloads worldwide. You ship a canvas to California with state and local sales taxes added to the price. You also sell a PDF coloring book to a customer in France, and suddenly owe EU VAT. Then mailing a t-shirt to New Zealand? You might have to charge a GST rate.

You didn’t leave your studio, but four different indirect taxes have already crossed your desk, each with its own rules, tax rates, and filing calendars.

Below, we break down these core taxes so you can spot them in your own business before tax authorities do.

Sales Tax

Sales tax applies to goods and services in the United States. It’s a single-stage consumption stage, levied in the supply chain.

For example, when consumers visit the mall and purchase a product, they are paying indirect taxes. Clothing, basic commodities, and household items are subject to these taxes. Upon payment at checkout, the retailer collects the local sales tax and remits it to the state’s tax department.

VAT (Value-Added Tax)

VAT is a form of tax, popular in the EU, that some countries refer to as the goods and services tax (GST). Businesses apply this at every stage of the supply chain, from when you produce the goods and services to the purchasing point. The VAT amount you use is based on the product cost minus the material costs taxed at the previous stage.

Let’s say a consumer is buying a cup of coffee. At checkout, the VAT rate they are paying (which could be 10% or 20%, for example) includes the entire production process, including cultivation, purchase of coffee beans, and processing, among other costs.

GST (Goods and Services Tax)

Think of GST as VAT’s cousin in countries like Australia, New Zealand, India, and Singapore. It’s levied every time value is added to the product throughout the supply chain.

For example, you sell a $50 poster to a client residing in Australia. You collect $5 as GST, and then you file a quarterly return through the country’s online portal. If you’re a high earner, this may have to take place every month.

Excise Tax

This is similar to sales tax, but businesses only apply excise taxes to specific products, such as airline fares, cigarettes, and fuel. You may refer to excise tax as an “environmental tax,” it aims to raise the cost of harmful products, making them less appealing to purchase.

Business owners pay excise taxes, but then the customer pays a higher fee. Consumers may not be aware of the exact amount of excise tax they are paying, as the total price typically includes the excise tax rate.

How indirect taxes work in practice

Imagine you sell digital design templates from Texas to a customer in Germany:

1. Texas has no statewide sales tax on digital goods, but Germany charges 19% VAT.
2. You must check whether you’ve crossed the registration threshold. EU member states have a 0 EUR threshold for digital goods, so you cross it upon your very first sale.
3. You now must register for VAT, collect 19% VAT on EU sales, file it, and remit.

If you also ship printed books to Canada, you’ll juggle federal GST, provincial PST, and possibly import duties at the border. One product, multiple tax rates – it’s easy to see why the indirect tax compliance burden grows as you scale.

If you run a business—even a small one like an LLC—you’ll likely deal with indirect taxes more often than you think. A key example is sales tax, which varies significantly from state to state.

Some states have no sales tax at all, while others impose high rates, and the rules about what’s taxable—and when you need to collect—can differ widely. These variations can affect your pricing, compliance requirements, and overall business strategy.

In addition to sales tax, business formation costs can also include indirect, tax-related expenses. For example, the cost of forming an LLC in Texas is $300 just to file for the Certificate of Formation. While not a tax in the traditional sense, this mandatory cost is an inherent part of doing business and functions similarly to an indirect tax, particularly when compared to states with lower or no filing fees.

Many new business owners don’t account for these kinds of expenses when calculating their startup costs, even though they’re essential for legal operation.

Together, state-specific sales tax rules and formation fees illustrate how indirect taxes and related costs can quietly add up, impacting your budget and long-term strategic planning more than expected.

Challenges of indirect tax compliance

Even when you understand the theory behind indirect taxes, staying compliant in real life can feel overwhelming. Here’s why the indirect tax compliance burden keeps business owners (and freelancers) up at night.

Rules that change overnight

Tax rates can change overnight. Some U.S. states might raise their sales tax, while others may lower it. And, as an eCommerce seller, you have to stay updated with what’s going on, as when something happens, you also need to update your prices. This ensures your business is in compliance with the relevant legalities and that you are not undercharging or overcharging.

Cross-border complexity

The moment you sell internationally, new layers emerge: customs duties, import duties, and local sales taxes. Shipping a $200 coffee grinder from Texas to Toronto will incur the Canadian GST, provincial PST, and possibly a courier-collected brokerage fee.

Send the same grinder to Brazil, and an extra consumption tax, plus federal excise duties, may apply. Every destination has its own compliance standards, and some require you to register once you reach a registration threshold as low as €10,000.

Learn more about cross-border e-commerce and how to do it right.

Multiple filings, multiple calendars

Each jurisdiction has its own filing frequencies and deadlines, which requires diligent record keeping and time management. For example, a single mid-size e-commerce brand can end up filing:

• Monthly VAT returns in Germany
• Quarterly GST in Australia
• Annual consumption tax in Japan
• Multiple state tax returns in the US

Different portals, passwords, and due dates mean a single missed click can lead to late-file penalties. And while direct taxes like business property taxes hit you once a year, indirect taxes may have to be filed every month.

Penalties

Skip a filing or pay the wrong amount, and tax authorities can:

• Levy fines that stack daily
• Charge retroactive interest
• Withhold imported inventory at the border, ruining holiday sales forecasts
• Suspend marketplace accounts, cutting off a vital source of revenue

The potential impact isn’t hypothetical; Amazon routinely de-lists sellers who can’t upload valid VAT IDs for EU markets. This highlights the importance of compliance in marketplace app development, ensuring that sellers can manage their tax obligations effectively.

Learn more about what happens if you don’t collect sales tax.

How Quaderno can help

Quaderno is a tax compliance software that can help you automate your tax processes. Quaderno takes the next step for you, automating calculations, filings, and invoices so you can focus on growing your business instead of wrestling with tax authorities.

Here’s what it looks like:

• Real‑time calculations using global databases of sales tax rates, VAT, and GST
• Invoice automations meeting local compliance standards, reducing human errors, and freeing up your time to focus on what matters most
• One-click reports for every jurisdiction, turning a weekend of spreadsheet misery into a one‑minute download
• Threshold alerts so you never overstep a registration threshold without knowing
• Tax registration and filing done for you, thanks to global partnerships.

In short, Quaderno turns a sprawling indirect tax compliance burden into a background task – freeing you to ship products, not paperwork.

Test Quaderno yourself. Sign up for your free 7-day trial now, no credit card required.

Thanks to Ryan Robinson of ryrob.com for sharing his expertise in this article for us!