Key takeaways
- Indirect taxes, including sales tax, VAT, and GST are collected by businesses on behalf of governments.
- Businesses must manage various compliance difficulties when operating across borders or offering digital products/services.
- Using tax automation software and seeking professional assistance can simplify indirect tax compliance.
In short: Indirect tax is a tax that businesses collect from customers on behalf of governments, rather than one paid straight to the government. The main types of indirect tax are sales tax, VAT and GST. Each works differently, and rates vary by country, state and product. The final consumer ultimately bears the cost.
Indirect taxes affect people and businesses alike. They raise a large share of government revenue. They also shape how consumers behave and how the wider economy works. In this post, we'll look at the main indirect taxes: sales tax, VAT, and GST. We'll explain their role in the economy and the problems businesses face in complying. We'll also share ways to make indirect tax compliance simpler.
What are the types of indirect taxes?
The main types of indirect taxes are value-added tax (VAT), goods and services tax (GST) and sales tax. What makes them indirect is how they are collected. Direct taxes, such as income tax and capital gains tax, are paid straight to the government by people or organizations. Indirect taxes are collected by businesses on behalf of governments.
Indirect taxes, such as sales tax, VAT and GST, vary by location, product type and jurisdiction. These taxes raise vital revenue for governments. This lets them fund public services and infrastructure projects.
For instance, in Ireland, children’s footwear is exempt from taxation, but adult footwear is taxed. This is one example of how complex indirect taxes can be.
Value Added Tax (VAT)
Value Added Tax (VAT) is a consumption tax charged on the value added at each stage of production or distribution. The origins of VAT date back to the 1950s. The idea is simple. Businesses collect VAT on the gap between the price of what they sell and the cost of what they buy. The final consumer ultimately bears the tax.
VAT rates vary a lot from country to country. In the EU, the standard VAT rate ranges from 17% (Luxembourg) to 27% (Hungary).
VAT is collected in several stages. Say a manufacturer sells goods to a retailer. The manufacturer charges VAT on the selling price. When the retailer sells the goods to a consumer, they charge VAT on the final price. But they can deduct the VAT they paid to the manufacturer. This way, VAT is only charged on the value added at each stage of the supply chain.
Goods and Services Tax (GST)
Goods and Services Tax (GST) is a consumption tax on goods and services, much like VAT. The key difference is its unified structure. GST combines several taxes, such as excise duty, service tax and sales tax, into one system. This makes the tax structure simpler, cuts waste and eases the admin burden.
Just like VAT, GST is collected at each stage of the supply chain. The tax is passed on to the next stage until the product reaches the final consumer. GST removes the cascading effect of stacking several taxes. This makes the system more open and efficient.
Putting GST in place can be complex, though. Businesses must follow the rules and show they can track and report their GST payments accurately.
Sales Tax
Sales tax is another indirect tax, but it's usually charged only at the point of sale to the end consumer. Unlike VAT and GST, sales tax ignores the earlier stages of production or distribution. Instead, it's a percentage added to the retail price of a product.
The seller must collect sales tax and pay it to the government. Working out the right sales tax rate can be complex in the US. Many states have hundreds of tax jurisdictions.
Sales tax rates vary widely by jurisdiction and by the type of goods or services sold. Some states or countries have exemptions or lower rates for certain essential items. This eases the burden on people with lower incomes. In the United States, state sales tax ranges from 2.9% to 7.25%. Many states also have local sales taxes that can average more than 5%.
What role do indirect taxes play in the economy?
Indirect taxes play a key role in raising revenue for governments. But they also have a regressive effect on income, because they apply to goods and services whatever the buyer earns. As a result, indirect taxes take a bigger share from people on lower incomes.
Even so, indirect taxes have been a main source of revenue for many years. They will likely stay that way, because governments need large amounts of funding.
Revenue generation
Indirect taxes raise revenue because they apply evenly to purchases of goods and services. This includes VAT and sales tax. The money helps fund public services and infrastructure projects. It also eases the load on direct taxes, such as income tax, by giving governments another source of revenue.
Businesses often face compliance problems with indirect taxes. These include cross-border sales, digital products and services, and keeping up with changing rules. To handle these problems and stay compliant, it's a good idea to use tax automation tools and get professional help.
Consumer behavior
Indirect taxes can encourage or discourage certain consumer behavior by setting different tax rates for different products or services. For instance, governments may tax harmful products, such as cigarettes, more heavily. They may tax greener products, such as electric cars, less.
Many governments around the world have raised taxes on cigarettes to discourage smoking. Meanwhile, taxes on electric cars have been cut to encourage more people to give up petrol cars and go electric. These examples show the power of indirect taxes to shape consumer behavior.
What indirect tax compliance challenges do businesses face?
The biggest indirect tax compliance challenges for businesses involve cross-border sales and digital products or services. For instance, the UK now has its own VAT registration process, separate from Europe’s VAT OSS, following Brexit.
In this context, businesses must collect taxes wherever they have customers, wherever they are based themselves. To do so, a business must first register in the state or country where it has met the registration threshold.
Cross-border transactions
Cross-border transactions are sales of goods or services between two or more countries. To comply with tax rules and thresholds in each country, businesses must deal with complex rules. They must also track their tax compliance in each jurisdiction. On top of this, they must make sure indirect taxes are applied correctly to each cross-border sale.
To make indirect tax compliance simpler, it's often wise to use tax automation tools and get professional advice. Luckily, more governments are reforming and upgrading their tax systems. This includes the digitization of indirect taxes and real-time reporting, which make the whole process easier for businesses.
Digital products and services
Digital products and services, such as software, music, videos and e-books, face different tax rules in different jurisdictions. This makes tax compliance more complex. Do your research so you know when indirect tax applies to a sale, and in which jurisdiction.
As businesses grow their digital offerings, understanding these rules matters more and more. If you're unsure, ask a tax professional. They can guide you and help your business stay tax compliant.
How can businesses simplify indirect tax compliance?
Businesses can simplify indirect tax compliance by using tax automation software and working with tax professionals. This matters more than ever in a global economy. Both help businesses handle complex tax rules and stay compliant. Read more in our guide: Strategic Tax Data Automation for Enterprise Finance Leaders.
Tax automation tools
Tax automation tools help businesses calculate, collect and pay indirect taxes accurately and quickly. These tools save time and resources. They also reduce the risk of errors in tax calculations and filings.
Taxually and Lumatax, for example, offer tax compliance software that eases the burden on businesses and streamlines their tax processes. This makes complex rules easier to follow. It also lowers the risk of costly penalties or fines for non-compliance.
Professional assistance
Getting help from tax experts is another good way to simplify indirect tax compliance. Tax professionals know complex tax rules in depth. They can help businesses with the details of indirect taxes, keep them compliant and make the most of tax savings.
They can also help businesses keep up with the latest tax laws and rules. This keeps tax compliance accurate and reduces the risk of penalties and fines.
What are the latest indirect tax reforms?
Recent indirect tax reforms include the digitization of tax processes and the move to real-time reporting systems. These reforms aim to modernize tax, improve compliance and reduce tax evasion. In the end, this strengthens a country's economy.
By keeping up with these trends, businesses can adapt to the changing tax landscape and comply with the latest rules.
Digitization of indirect taxes
The digitization of indirect taxes offers several benefits, including:
- Simplified tax compliance.
- Less need for paper-based processes.
- E-invoicing removes the need for paper invoices. Businesses can create, send and receive invoices electronically.
- The ecommerce VAT package introduced by the European Union creates a fairer environment for businesses. It also improves the collection of VAT on online sales.
By embracing digitization, businesses can stay on top of tax compliance, reduce errors and adapt to the fast-changing tax landscape.
Real-time reporting
Real-time reporting systems make tax transactions more transparent and reduce non-compliance. These systems require businesses to report their tax transactions to the tax authorities promptly. This supports accurate tax compliance and lowers the risk of penalties or fines.
Real-time reporting can take businesses a lot of time, though. That's why tax software is so useful. It can help with real-time reporting, saving businesses time and money.
Conclusion
Understanding indirect taxes is essential for businesses in today’s global economy. Learn the main types of indirect taxes, such as sales tax, VAT and GST. Then keep up with the latest changes to tax rules. This way, businesses can handle complex tax rules and stay compliant. For a closer look, see 5 Global Indirect Tax Trends to Look Out for in 2024 and Beyond.
Do you need help with your VAT compliance? Book a free call with one of our VAT experts to find bespoke solutions for your business, optimize your VAT costs, and reach millions of new potential customers.
How Taxually handles this
Taxually is one platform for cross-border tax compliance: CrossTax for VAT registration and returns, LumaTax for US sales tax, EcoTax for EPR and OneTax for tax payments. It connects to Amazon, eBay, Shopify and Stripe, so you can sell in new markets without managing each tax authority yourself.
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Frequently asked questions
What are indirect taxes in the UK?
In the UK, indirect taxes such as Value Added Tax (VAT) and excise tax on cigarettes and alcohol are levied on goods and services to raise revenue.
National Insurance is not considered a tax.
Is VAT an indirect tax?
Value Added Tax (VAT) is a form of indirect taxation that is applied to goods and services during the production and distribution process. It's part of a broader scope of taxes, including customs and excise duties.
What does indirect tax mean?
An indirect tax is a type of taxation imposed on producers of goods and services that is ultimately paid for by the consumer.
Common examples of indirect taxes include Value Added Tax (VAT), excise duties, and import taxes.
What is the main difference between direct and indirect taxes?
Direct taxes are paid directly to the government by taxpayers, while indirect taxes are collected by businesses and then passed on to the government.
