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Sales Tax vs VAT vs GST - Your Guide to Consumption Taxes

 Sales Tax vs VAT vs GST - Your Guide to Consumption Taxes

Oh, the wonderful world of sales taxes. So many different delights to learn about, how could you choose just one?

Well, we’ll choose for you. If you’re a business owner of any kind, you must understand consumption taxes. It touches every stage of production and every point of sale.

  • Every time you pay for a material or service to create your product, you could be paying some amount of consumption tax.
  • Every time you sell your product to a customer, you should be charging some form of consumption tax.
  • Every tax season, you should be sending off a chunk of consumption taxes that you’ve collected.

We’re talking sales tax, VAT, GST, and a few others you’ve likely heard of — especially if you’re selling outside of your home base.

Yep, as a business owner, you’re basically swimming in an ocean of consumption taxes, which each have different currents and speeds. We’ll explain what consumption taxes are, and most importantly, what the differences are between VAT, GST, and US sales tax.

What are consumption taxes?

Consumption taxes are applied to the purchase of goods and services. There are different kinds of consumption taxes, depending on the country. They can be a flat rate applied to every transaction, or a percentage of the total value. Each type requires something different from you, the business owner.

But one element always stays the same. The end customer pays the tax, because they are who’s actually consuming the end product. And it’s a tax on consumption. On buying and spending for one’s own personal use.

Why tax this? For government revenue, of course. Some governments charge a consumption tax instead of an income tax. Or, if you live in the EU, you have both.

Charging on consumption can be tricky, though, and requires an economic balancing act. The tax rate needs to be high enough that the government gets their funding, but not so high as to discourage consumer spending. If customers stop buying, then there’s less overall tax to collect anyway — and businesses like yours are hurting in the process. No good.

Who pays sales tax, VAT and GST?

To understand how consumption taxes work, it’s actually easiest to begin at the end: the final point of sale to the end consumer.

At the final point of sale, the end consumer pays the tax to the vendor (that’s you). The vendor collects that tax and sends it along to the government when taxes are due. So you can think of yourself as the middleman for these consumption taxes.

But sometimes there are payments of consumption tax before that final sale. Some governments charge tax at each stage of the production process, from whoever contributes to the final market value.

But this all depends on what type of consumption tax it is, so let’s parse them out.

What is Value-added Tax (VAT)?

Value-added tax (VAT) is one where the consumption tax is charged at each stage of the production chain. At each stage, it’s assumed there’s an increase in value of the good or service. That increase, the “value added,” is what’s being taxed. But the cool thing is that, as a business owner, you get back whatever VAT you’ve paid in the chain. Only the end consumer pays out of pocket.

How exactly does this work? So, you pay some amount of VAT to other businesses who help you make your product. These slivers of VAT are called “input taxes,” and you get a tax credit for them.

At the end of the season, once you’ve collected VAT from all your customers (“output taxes”), you are supposed to send the VAT to the government, right? Right. But first, you can discount all the input tax from the total, so that money goes back in your pocket.

If you’d like to learn about how VAT works in the EU specifically, check out our ultimate EU VAT guide.

What is Goods and Services Tax (GST)?

A Goods and Services tax (GST) is also levied at every step of the supply chain. But unlike VAT, GST is charged regardless of what value is added; it’s usually just a flat-rate percentage of the transaction.

In Australia, GST works like so: The businesses are charged at each stage of the manufacturing process, and the end customer is charged at the point of sale. The GST is then refunded to everyone through tax credits, except the end consumer.

What is US Sales Tax?

Technically, all of these taxes listed could be called a type of “sales tax”. But what we mean here is a simple, one-time tax charged at the point of purchase. The money goes from the consumer, to the vendor, to the government, the end. This form of sales tax exists throughout the United States, determined at the state and local levels. (There is no overarching national sales tax in the US.)

Because the states and local municipalities can all decide their various rules, sales tax in the US is notoriously complicated… To understand how the system works, check out our primer on US sales tax on digital products.

Try out our sales tax calculator, to determine your product’s tax rate, amount, and final price for any location in the world, just by entering a postal code.

VAT vs Sales Tax

From your perspective as an online business owner, VAT and sales tax are more similar than they are different. It’s just that VAT is the most common consumption tax system in the world, while sales tax exists only in the United States.

That said, the primary difference between VAT and sales tax lies in how the taxes are applied throughout the production chain.

Imagine you're buying a smart tablet from a retailer in the US. Let's say the tablet costs $200, and if you're in a state with a 7% sales tax, you'll pay $214 at the checkout. Subsequently, the retailer forwards the $14 collected in sales tax to the state.

What many US consumers may not realize is that, in this scenario, they bear the entire burden of the sales tax. However, this isn't the case under VAT systems.

In a VAT system, the tax burden is spread across various participants in the supply chain. For instance, in our smart tablet example, there are materials suppliers, manufacturers, retailers, and consumers involved in the transaction. Each of these players contributes to the €14 tax burden, as the product is transacted forward. The end consumer only pays a smaller share of it!

The less-common consumption taxes

The last couple are two that your business probably won’t encounter often, especially if you sell digital goods. Nevertheless, they’re in the consumption tax family. To have a better vocabulary and a basic understanding, it doesn’t hurt to know these taxes by name and how they operate.

Import duties or tariffs

Of course you know about imports. They’re half of the age-old trade economy! Import duties, also known as tariffs, are consumption taxes levied on certain goods when they enter a country. The tax goes to custom agencies. Usually, this is how it plays out: the importer pays the duty to customs when the product first arrives. He then passes the cost to the end customer, adding it to the price of the item.

Aside from raising money for the local government, another goal of import duties is to protect local producers and domestic markets. A country may feel threatened by cheaper goods coming in from elsewhere. To protect their economy, they might add tariffs on certain imports to make them more expensive and, obviously, less attractive.

It’s important to pay attention to customs and import tax rules if you have a dropshipping business. While sales tax rules for dropshipping are complicated alone, there’s even more complexity if you’re importing goods!

For example, in the US there are several different fees attached. When you import products in bulk with a value over $800, then the import taxes will include the customs duty, a merchandising processing fee, and port maintenance fees. The duty rate will depend on the value of the imported product and the HS (or HTS) code of the product. (You can check the HS code of your product and its import duty directly on the US International Trade Commission website).

Excise tax

This is a sales tax applied to specific goods, usually to discourage people from buying them because the government views those items as being bad for society at large. This usually means items like cigarettes, alcohol, gasoline, etc. Yep, the “bad stuff.” Actually, this tax is sometimes called the “sin tax.”

The government wants to regulate consumption, and they do so through applying a special tax, an excise tax. This is initially paid by the manufacturer, then passed along to the consumer in the final purchase price.

Final word

Knowing the various types of consumption tax is important, but it’s actually not enough to run a smooth, tax-compliant business. Even among the countries in the world who use VAT, their VAT systems could be wildly different from each other. Each tax system can have its own national quirks, not to mention different rates.

So how can you truly stay on top consumption taxes, while still running your business? You can find a software solution that automatically handles sales tax and tracks any changes to tax policy around the world.

Don’t let sales taxes consume any more of your time. (Yes, pun intended.) Exit the maze and let Quaderno navigate world-wide digital tax laws for you. Every transaction is tax compliant, no matter where your customer is based. You never have to worry about collecting the right amount of consumption tax o about keeping the right records. With Quaderno charging the right amount of tax is automatic, and the customized receipts are, too. Sound too good to be true? Check out how we’ve solved digital taxes for online creators.

Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the tax authorities.