As a customer, you’re probably familiar with indirect taxes. These are taxes that are levied on most goods and services. Since they usually appear as a line item on receipts as “sales tax” or “value-added tax,” you probably don’t think twice about them. However, for businesses, indirect tax compliance is more complicated.

Below, we’ll cover what you should know about indirect taxes for businesses, including types of indirect taxes and when you should be collecting these taxes from your customers.

What’s in this article?

• What is an indirect tax?
  
• How does an indirect tax work?
  
• Types of indirect taxes
  
• Pros and cons of indirect taxes
  
• Examples of indirect taxes
  
• When to collect indirect taxes
  
• How to file and remit indirect taxes
  
• How Stripe Tax can help
  

What is an indirect tax?

An indirect tax is a tax collected by an intermediary, such as a seller or manufacturer, and ultimately passed onto the government. When you pay sales tax on a product, for example, you’re paying an indirect tax. Indirect taxes may also be built into the listed price of a product, the price that a customer sees even before they take the product to the register, which is the case with VAT/GST, tariffs, or excise duties.

Businesses and retailers collect these indirect taxes on behalf of municipalities and governments. Each country—and less commonly, each state—creates its own specific regulations that often change as product offerings evolve and in response to the dynamic economic landscape. Indirect taxes can apply to physical and digital goods, as well as services.

Differences between direct and indirect tax

Direct tax and indirect tax are two separate types of taxes that operate in distinct ways.

Direct taxes

• Based on earnings and revenue (e.g., income tax)
  
• Paid directly to the government by individuals and organizations
  
• Charged proportionately to assets or income level
  
• Progressive taxes (takes a higher percentage from higher-income taxpayers)
  

Indirect taxes

• Based on purchases of goods and services
  
• Paid to businesses who then remit the tax to the appropriate government tax authority
  
• Charged based on the value of the service or good
  
• Regressive taxes (takes a higher percentage from lower-income taxpayers)
  

How does an indirect tax work?

An indirect tax is collected by a business or other intermediary. In many cases, businesses accomplish this by adding the tax to the total purchase price of a good or service. Then, the business or intermediary reports and pays those taxes to the government on a periodic basis—often monthly, quarterly, or annually. Much of the process happens with little direct involvement from the consumer, who often only takes part by paying their total bill for a good or service.

Types of indirect taxes

Indirect taxes have different names in different countries or regions. The amount of tax charged depends on the purchase price, as the tax is levied as a percentage of that price. Here are a few examples of indirect taxes:

• Value-added tax (VAT): VAT is a type of indirect tax that applies to physical goods or services. It’s called “value-added tax” because it’s charged whenever value is added to the product throughout the supply chain, from production to the point of sale. VAT is commonly found in Europe.

• Goods and services tax (GST): GST is a tax similar to VAT in that it is levied whenever value is added to the product throughout the supply chain. GST is commonly found in Canada and the Asia-Pacific region.

• Sales tax: Sales tax is another type of indirect tax levied on the sales of certain goods and services in the US. Sales tax is different from other types of indirect taxes, in that it is a single-stage consumption tax imposed on retail sales. It is only levied once in the supply chain.

• Excise tax: Excise tax is similar to sales tax but applies only to sales of certain products. Popular items that are subject to excise tax are cigarettes, gasoline, and airline tickets. Excise tax and sales tax can be applied to the same purchase, or excise tax can be applied when sales tax is not.

Pros and cons of indirect taxes

As with any financial mechanism, indirect taxes have benefits and downsides for businesses. Here’s what to keep in mind.

Advantages of indirect taxes

• Indirect taxes can be collected from anyone, regardless of income level. With this type of tax, everyone can contribute.

• They can fly under the radar. Indirect taxes are rarely listed on price tags, and some types are even part of a product’s base price, rather than tacked onto the final purchase price at the register. Due to this lack of friction, indirect taxes don’t always come with the negative feelings that some consumers associate with direct taxes.

Disadvantages of indirect taxes

• Disproportionate burden on consumers with lower incomes. Indirect taxes are regressive taxes. Since the rate stays the same for every consumer, indirect taxes end up taking a higher percentage from lower-income earners.

• Consumer behavior can decrease revenue. If a consumer wants to pay less indirect tax, they can decide to buy fewer goods and services for a period of time, which can impact government revenues. This can be a concern for municipalities and organizations that budget with the expectation of bringing in a set amount of indirect tax-based cashflow in a given year or quarter.

Example of indirect taxes

Consumers often encounter indirect taxes when making purchases. For example, if a consumer purchases a jacket at a store in a US state that levies sales tax (most states do), they might pay $50 for that jacket at the register. That is the correct total price of the jacket, but the receipt will itemize the jacket’s actual product price before sales tax, as well as how much in sales tax was added to the total price. With state and local sales taxes combined, the range is usually between 5% and 10% of the product’s actual price.

When to collect indirect taxes

In general, businesses are required to collect indirect taxes wherever a sale occurs, regardless of where your business is located.

• In the US, businesses are only required to collect sales tax when they create a connection to a state. This is referred to as “nexus.” Nexus can be met by exceeding an economic nexus threshold or by establishing physical nexus. Economic nexus is based on revenue or transaction amounts and varies by state. Physical nexus is met by having a physical presence in a state, such as an office, employees, or stored inventory.

• In the EU, the threshold to collect VAT varies by country. If you perform a transaction that’s taxable in an EU country other than the one where you’re established, you generally must collect VAT in that country unless the transaction is exempt or subject to reverse charge (which typically applies in business-to-business scenarios, such as SaaS offerings). Non-EU businesses selling digital products to EU customers typically must collect tax from their first transaction.

• If you are based in Canada and your total worldwide taxable supplies exceed CAD $30,000 in a single calendar quarter or over the past four consecutive calendar quarters, you must register for the goods and services Tax (GST) and harmonized sales tax (HST). The same registration threshold applies to nonresidents selling digital services to Canadian consumers.

Some provinces require you to collect separate provincial taxes on top of the federal GST/HST.

How to file and remit indirect taxes

Before you collect any taxes from your customers, ensure you are registered with the appropriate tax authorities. In the US, businesses must register for sales tax permits with each individual state. In the EU, businesses generally must register in individual countries to collect VAT, but if they sell to individuals in other EU countries, they may use the VAT OSS scheme. Find more information on registering in different countries here.

Once you collect indirect taxes from your customers, you will file a tax return and remit the tax you collected to the correct tax authority. Each tax authority’s website will have details on how to file, and your due date. Due dates vary, and the frequency in which you file a return may also vary. In the US, large companies with a higher tax liability will often file more frequently, such as monthly, while smaller companies might file bimonthly or quarterly. In the EU, most businesses file monthly. Filing on time is the best way to avoid the penalties and interest that come with a delinquent filing.

Even if you have not collected tax during a reporting period, you may still need to file a return. These are called “zero returns,” and while you will not remit any tax to the state, you are still required to file a return.

Stripe Tax can make filing and remittance easier. Users benefit from a seamless experience that connects to your Stripe transaction data—letting our trusted global partners manage your filings so you can focus on growing your business.

How Stripe Tax can help

Stripe Tax reduces the complexity of tax compliance so you can focus on growing your business. Start collecting taxes globally by adding a single line of code to your existing integration, clicking a button in the Dashboard, or using our powerful API.

Stripe Tax helps you monitor your obligations and alerts you when you exceed a sales tax registration threshold based on your Stripe transactions. It can also register to collect tax on your behalf in the US and manage filings through trusted partners. Stripe Tax automatically calculates and collects sales tax, VAT, and GST on:

• Digital goods and services in all US states and over 100 countries
  
• Physical goods in all US states and 42 countries
  

Stripe Tax can help you:

• Understand where to register and collect taxes: See where you need to collect taxes based on your Stripe transactions. After you register, switch on tax collection in a new state or country in seconds. You can start collecting taxes by adding one line of code to your existing Stripe integration, or add tax collection with the click of a button in the Stripe Dashboard.

• Register to pay tax: If your business is in the US, let Stripe manage your tax registrations, and benefit from a simplified process that prefills application details—saving you time and simplifying compliance with local regulations. If you’re located outside the US, Stripe partners with Taxually to help you register with local tax authorities.

• Automatically collect tax: Stripe Tax calculates and collects the right amount of tax owed, no matter what or where you sell. It supports hundreds of products and services and is up-to-date on tax rules and rate changes.

• Simplify filing: Stripe Tax seamlessly integrates with filing partners, so your global filings are accurate and timely. Let our partners manage your filings so you can focus on growing your business.

Learn more about Stripe Tax, or get started today.