Sales tax is the most common overseas tax which international traders have to deal with. John Galvin explains them here.
Here’s a TRUE or FALSE question for you this month: Is it correct that the most common overseas tax faced by international trading businesses should not cost them anything?
Strangely enough, the answer is TRUE and the tax in question is sales tax, commonly known as VAT or GST. In this article I will explain more about sales tax and give you some tips to ensure it is not a burden for your business. As sales taxes vary all over the world, please note that not all these comments may apply to every country.
Sales tax is the most common overseas tax which international traders have to deal with. Overseas sales tax can apply even if a business has no business operation, legal entities or employees based overseas.
Why is this?
The clue is in the name. Sales taxes are driven by sales activity. If your business is selling to overseas customers, then it may need to register, file and pay sales tax in one or more overseas countries.
Who pays sales tax?
Typically sales tax should cost your business nothing other than the cost of administration, although this can vary depending on the sales tax operated in your region. The reason is that it is ultimately a tax borne by the end consumer. Your business is merely acting as a collection agent on behalf of the tax authorities.
However in practice it often does feel like any other tax. If you collect the wrong tax or your documentation is poor, your business is liable to make good any shortfall in taxes to the authorities and pay fines. Also sales tax increases the price of your products, so it is extremely important to apply the correct rates.
Why is this important?
If you manage sales tax correctly, you will potentially save your business significant sums by:
Minimising the taxes you pay, which improves your profitability and customer pricing;
Keeping on the right side of international tax authorities;
Avoiding any need to re-issue customer invoices; and
Reducing the amount of time and cost of preparing and filing tax returns.
How do sales taxes work?
Sales tax is a tax on the sales which your business makes overseas. Sales taxes are applied by the business to their customer. They need to be added onto the net price before sales tax, usually at a set percentage of the net price. The sales tax is usually shown on the invoice as a separate component of the sales price.
The business collects the tax when the invoice is paid by the customer. It needs to keep separate accounts for the taxes so it can hand them over to tax authorities. The business has to inform the tax authorities on a regular basis how much it has collected and it has to pay over the taxes. Often these filings are very detailed and accompanied by statistical returns about your trading.
The payments are reduced by any tax that the business has itself paid on its own purchases. Therefore in its sales tax returns, the business has to show both the taxes received and paid, and it typically has to pay over the net difference.
Why doesn’t my business pay sales tax in my country?
The most likely answer is that your business does pay sales tax, but it has a different name in your country or region. Sales taxes have a variety of different names, e.g.:
– Sales Tax in U.S.
– Value Added Tax (VAT) in Europe
– Goods and Services Tax (GST)
How do I know if my business is liable for overseas sales tax?
The rules around sales tax eligibility are highly complex, particularly for international businesses. Relying on Google is a dangerous tactic as there are many exceptions and constant changes to the rules and rates. If your business is selling to customers, either business or consumers, in another country you should take advice from a sales tax expert to determine whether you need to:
Charge your own domestic rate of sales tax
Charge the sales tax rate of the overseas country
Exempt the sale from sales tax.
Capture all the information which is parameters involved in deciding which VAT rate to use
Have intelligence to calculate the correct rate, with checks and balances
Have links to current VAT rates, which are constantly kept up-to-date
Also, in some cases it may be at your discretion whether to apply sales tax or not. In these cases your business should evaluate the pro’s and con’s of registering with local tax authorities to apply sales tax.
What are the reasons for registering if my business is not required to do so?
There are a number of good reasons to register even if this is not strictly required. If your business pays over more sales tax on your purchases than you collect from customers, then you typically can reclaim cash. Also it may enable your business to benefit from free trade agreements, import duty reductions and other international benefits.
What do I need to do to register for sales tax?
All countries require businesses to be registered for sales tax before they can make filings and payments. The registration rules vary from country to country. Sometimes a sales tax registration is automatically included when you register your business as a legal entity, but in most countries you have to make a specific registration for sales tax. Most businesses outsource this task to a local accountant or sales tax expert as it requires specific local knowledge and language skills.
What happens if my business charges the wrong tax rate?
Although the ultimate sales tax is borne by the customer, the onus is on each business to administer the tax correctly. If your business applies the wrong tax, you should expect to pay over any shortfall to the tax authorities. Many countries have review procedures in place so that the tax authorities can identify any anomalies or unusual items immediately.
You should also consider crediting the original invoice and re-issuing corrected invoices to your customers with the accurate VAT rates. This will enable you to reclaim any payments from your customers. However this is administratively very inconvenient for your customers from a cash and administration perspective. They may need to pay over additional cash to you if your business undercharged sales tax in the first instance.
You should also be aware that frequent mistakes can mean your business faces more frequent tax audits, which are extremely time-consuming and costly. Also this can lead to civil and criminal charges depending on the particular laws in the country involved.
How frequent are the filings and payments?
Sales taxes are most commonly due on a monthly or quarterly basis. However the frequency can vary from country to country and even from business to business.
There are usually strict timetables in place for both the filings and the payments. Authorities enforce these timetables strictly and you should expect them to impose fines if you miss deadlines. Also there is often an annual return required at the end of the fiscal year.
How onerous are the filings?
The calculation of sales taxes and the preparation of filings can be a very onerous task. This is because the rules across countries are subject to so much variation and the returns required are often highly detailed.
In my experience it is the sales component of the filings that is the most onerous element. This is because sales taxes can vary from product to product and also location to location.
Do you have any tips for helping to make this easier?
There are many ways in which your business can make life easier. Here are my top tips:
Billing: For any company which is sending invoices to customers overseas, it is advisable to have a billing system which can systematically capture the correct VAT rates. This will reduce any manual input for VAT rates and the error rates. The system should:
Templates: If you outsource your overseas VAT returns, try to give information to your accountant in an orderly template form rather than handing over raw data. This will make your accountant’s task easier and will lead to lower costs for you. It will also reduce the possibility of errors.
Keep your records: As sales tax audits can be carried out by tax authorities many years after the event, keep full records of the calculations which support your tax returns and any documentation necessary. Check how long you need to keep records for and whether scanned electronic copies of invoices will be acceptable to tax authorities. Scanned copies are much easier to store and retrieve.
Accounting: When trading in multiple sales tax jurisdictions, it is also helpful to have a separate balance sheet account or code for each country’s sales tax. If multi-country sales taxes are grouped together into one collective code on the accounting ledger, it can be very difficult subsequently to reconcile how much tax is due in each country.
How should I resource sales tax?
My golden rule is that a sales tax specialist should be responsible for sales tax returns. If you do not have the resources to have an internal sales tax specialist, then you should outsource this to an accounting firm or specialist tax firm.
I would go further and advise you to make sure that your sales taxes are produced or reviewed by a local country expert. Sales taxes vary widely from country to country, and they change frequently
How can I get more help or find a specialist?
Ask me on email@example.com or submit a question on my secure website at http://www.galvininternational.com/blog/forums/. We’ll make sure you get all the help you need.
John Galvin MA ACA, has 20 year’s experience in CFO and other senior executive positions with multinational Blue-Chips and SME’s. He regularly contributes to international finance events and publications. His company, Galvin International, www.galvininternational.com provides international accounting, tax, payroll, HR and legal services in over 50 countries.