In the simplest possible terms, VAT (or, “value added tax”) and sales tax are both consumption taxes. Both generate revenue for local, state or country-wide governments through the sale of goods and services.
But when you dig a little deeper, you’ll see that’s where the similarities stop...
How VAT and Sales Tax Work in Practice
The biggest difference between VAT and sales tax is how they’re applied throughout the production process.
Say you want to pick up a pair of headphones at a US retailer. You pay $50 for the headphones and, if you’re in a state with a 10% sales tax, you’ll pay $55 at the register. The retailer then remits the $5 you paid in sales tax back to the state.
What most US buyers don’t recognize is that, in this scenario, they’re the ones covering the full burden of the sales tax. This isn’t exactly the case under VAT systems.
Instead, VAT transfers some of the tax responsibility to others involved in the supply chain. Following our headphones example, you have materials suppliers, manufacturers, retailers, and consumers who are all involved in the transaction.
Let’s assume that the materials supplier sells the headphone components to the manufacturer for $5, and that the manufacturer sells the finished headphones to the retailer for $25.
Under a VAT scheme of 10%, the supplier would markup the headphone components to $5.50 and file the $0.50 with the government as VAT. Next, the manufacturer will charge the retailer $27.50, but instead of remitting the entire $2.50 in tax charges to the government, they’ll send $2.00 and claim the remaining $0.50 as a refund for the VAT already paid to the supplier.
This process continues up the ladder until it reaches the consumer. Our fictitious retailer, for example, would sell the headphones to the consumer for $55.00, but will then be able to claim a $2.00 VAT refund for the taxes already sent to the manufacturer.
Are You Required to Pay VAT?
Let’s be clear. The example above is a huge simplification.
What happens if the supplier, manufacturer, and retailer are all in different countries?
What if multiple suppliers sell into a single manufacturer?
While it’s helpful to walk through examples like these in order to understand whether or not VAT is the same as sales tax, they’re only useful to a point.
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