UK clients often assume that US sales taxes operate essentially like VAT. While both are consumption taxes, the similarity ends there. So, how do US sales taxes differ?
- Who collects and pays the tax. VAT is a tax imposed on the value added at each stage of the production and distribution of goods or the provision of services. As a result, output taxes are charged at each sale in the chain, with a corresponding right to reclaim any input taxes paid. US sales taxes, in contrast, are collected from the end user only. Thus, goods sold for resale are generally exempt from sales tax, as are raw materials used in manufacturing. In the end, the consumer theoretically bears the incidence of the tax under either system. But, the two systems arrive at this result in different ways.
- Uniformity. VAT is applied uniformly throughout the United Kingdom. In the United States, in contrast, each state has different laws governing what is subject to tax and at what rate. In fact, it is common for localities (e.g., cities and counties) within states to have their own sales tax rates. Consequently, a US company could be required to collect sales tax at many different rates determined by the customer’s location and to remit the tax to as many as 50 different state jurisdictions and even to local jurisdictions.
- What is subject to tax. In the UK, almost all goods and services are subject to VAT. In the US, however, sales taxes are typically imposed only on the sale of tangible personal property. Each US state decides for itself which goods and services will be subject to tax. In recent years there has been a trend among the states in favor of taxing more intangible property (e.g., downloadable software) and more services. However, sales taxes are still imposed overwhelmingly solely on sales of tangible personal property.
- The rate of tax. Whereas in the UK, VAT is usually 20%, US sales tax rates are much lower. Four US states (Delaware, Montana, New Hampshire, and Oregon) have no sales tax whatsoever. Of the remaining states, sales tax rates can range between 4% to 11.5%. As in the UK, most US states have opted to impose reduced or zero-rates on certain goods (in the US, for example, on food and medicine).
- Who must collect the tax. In a unitary system like the UK, the government can impose on any UK company the obligation to collect and pay VAT. In our federal system, in contrast, a state’s power to require out-of-state companies to collect sales taxes is more limited. Traditionally, the US Supreme Court has ruled – based upon its interpretation of the so-called “dormant commerce clause’ of the US Constitution – that a state cannot require a company to collect sales taxes on sales to residents of that state unless the company has a “physical presence” in the state. In 2018 this rule was overturned by the US Supreme Court, giving rise to a series of “economic nexus” rules which vary by state. Generally, a state can require an out-of-stock corporation to collect sales tax on sales to residents of that state if: (a) the corporation has employees or sales representatives in the state; (b) the corporation has stock warehoused in that state; or (c) the corporation has transactions in a twelve month period in excess of certain thresholds (which are often, but not always, 200 individual transactions or $100,000 in gross receipts).
These rules apply to UK companies doing business in the US in the same way that they apply to US corporations.
Despite these differences, the UK’s VAT system and the US sales tax system are alike in one key respect: governments impose harsh penalties upon companies that fail to collect and pay over the required tax. In fact, in the US, companies that are required to collect sales tax are liable for the sales tax, even if they are never collected. In addition, the company’s owners, officers, or directors can be personally liable for any amount collected but not paid over.