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A conundrum facing companies starting business activities in the U.S. is the confusing world of sales and use taxes. Having spent their economic lives under the value added tax scenario, sales and use taxes may seem incomprehensible. In this article we will note those areas of differences and help demystify the state tax regime faced in the U.S.

Value Added Tax

The value added tax (“VAT”) is the taxing regime in most of the world excluding the U.S. It is a consumption tax applicable at each stage of the production chain. The VAT was first introduced in France in 1954 although the concept had been around since 1918. While it was initially directed at large business, it was gradually expanded to cover all business entities. Beginning with rates in single digits in some European countries, rates in EU for 2014 are as high as 25%.

Some characteristics of the VAT are:
  • It is generally imposed on both goods and services.
  • It is imposed at each stage of production.
  • It is typically included in the price the purchaser pays.
  • The seller charges the VAT to the purchaser and remits to the government if the purchaser is the end user.
  • If the purchaser is not the end user and the goods or services are costs to its business, the purchaser can deduct the VAT it pays from the VAT it charges to its customers. The government only receives the difference.
  • There are no exemptions requiring documentation although some items may be “zero-rated” such as medicines.
  • There may be increased costs in hiring additional staff to handle the VAT paperwork for wholesalers without compensation by the government.
One advantage of the VAT is that the seller is not placed in the position of having to rely on the purchaser to document any exemptions. Under the VAT, all sellers collect the tax and pay it to the government.

Sales and Use Tax

The sales and use tax (“SUT”) originated in the U.S. during the Depression. The first broad based sales tax was enacted in Kentucky and Mississippi in 1930. There are 45 states and the District of Columbia that have enacted a SUT. This results in a confusing array of definitions for what is taxable and what is not taxable. SUT rates in the U.S. hover around 8% and rarely exceed 10%.

Some characteristics of the SUT are:
  • It is generally imposed on the sale of tangible personal property and designated services. Each state determines what is taxable in the categories.
  • It is imposed on the end user.
  • Sales tax must be separately stated on the invoice.
  • Only sellers who have nexus in a specific state will have the responsibility of collecting and remitting the sales tax.
  • If the purchaser is not the end user, he may submit an exemption certificate to the seller to eliminate the sales tax. There are different exemption certificates per state and per type of exemption. States will only accept their own exemption certificates.
  • The sales tax return is filed only by retailers and there is usually a vendor’s compensation available to offset the costs of compliance. This will vary by state.
  • There is a use tax which purchasers must accrue and remit to the state if any taxable purchase does not have a sales tax on the invoice. 
As can be seen, the SUT is not as straightforward at the VAT and can be confusing for foreign companies who expect to confront one transaction tax at the federal level rather than over 40 separate taxing jurisdictions, rules, and rates. Both the seller and purchaser can be audited and be held liable for the tax. In addition, the idea of nexus has been expanding in recent years to bring in more and more companies into a state’s taxing web. 
Over the years, the U.S. has considered a federal VAT. In 1969, President Nixon’s administration was considering a VAT to be shared with state and local governments to reduce the dependence on property taxes and to fund education. In October 2009, then-House Speaker Nancy Pelosi states that a federal VAT was “on the table” in order to increase government revenue. However, at this point the federal VAT has not progressed beyond discussions.

If you have any questions or would like additional information on UHY Advisors’ State and Local Tax Services, please contact Ted Clark, National Director of State and Local Taxes or Patricia Klemz, National Director of Transaction Taxes.