When thinking about tax from a business perspective, there are 4 categories to consider:
- Tax on your company’s profits
- Employment-related taxes
- Import taxes
- Tax you charge your customers
As an online business, the first two types of tax will only be a problem in the country where your business is set up, unless you have offices with employees in multiple countries. For the most part, you can sell to customers anywhere in the world and you won’t have to worry about paying the foreign tax man a piece of your profits. Unless you have employees in other countries, you certainly won’t have to worry about employment taxes. If you are moving physical goods around the world, import tax and excise duties needs to be factored in, but we’ll that topic for another time.
In most cases, the only tax an online business needs to care about in other countries is what is called Consumption Tax – the tax your customer pays when they purchase your product. Tax offices around the world can decide what consumption tax system to implement – the most popular is a Value Added Tax regime (“VAT”), which also goes by the acronyms GST (in place like Australia, Canada and Singapore) or JCT (in Japan). The name is irrelevant really, because this kind of consumption tax walks and talks the same.
The other class of consumption tax is usually referred to as Retail Sales Tax (or in the USA, it is mostly called Sales and Use Tax). Ultimately, it is identical to VAT – a seller must add tax to all their eligible sales in a tax jurisdiction and then pay that over to the tax office – but there are subtle differences. Sales Tax is a retail tax: it is mostly charged to private individuals, whereas VAT is charged to business customers as well. Simply put: VAT is different to retail sales taxes because VAT is charged at each step of the production process, rather than one tax at the end. (That’s where the term “value added” comes from).
In both cases, the seller becomes a tax collector for the government: they add tax to their sales price and pay over this extra cash collected when they file the required tax return. VAT is much simpler in some ways: there is usually one VAT rate that is levied on all transactions in that jurisdiction. Sales Taxes tend to be much more granular: the rate that needs to be applied is dependent on both the type of product being sold and the specific tax jurisdiction.
For example, if you sell shoes to a customer in Germany, the 19% rate of VAT applies in all cases. If you sell the same pair of shoes to a customer in California – the rate of tax might be 7.25% if the shoes are delivered to Los Angeles, but San Diego might allow a reduced rate of 5% on certain types of shoes. Within each US state there can be hundreds of different tax jurisdictions, and each of the 47 states who have implemented Sales Tax have different rules – so it is a much more complicated system for a seller to determine how much tax to charge.
The key in all cases is to understand your obligations – because if you fail to charge the consumption tax on your sales, the government has various ways they can punish this non-compliance.