As a customer, you’re likely familiar with indirect taxes. These are taxes that are levied on the purchases of most goods and services. Since they usually appear as a line item on receipts as “sales tax” or “value-added tax,” you likely don’t think twice about them. However, as a business, indirect tax compliance is more complicated.
Here’s a guide to what you need to know about indirect taxes, including types of indirect taxes and when you should be collecting these taxes from your customers.
Related report: Global tax trends and changes for 2024
What’s in this article?
- What is an indirect tax?
- Types of indirect taxes
- When to collect indirect taxes
- How to file and remit indirect taxes
What is an indirect tax?
Businesses and retailers collect indirect taxes on behalf of municipalities and governments. Each country and state creates their 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.
Direct tax and indirect tax are two separate types of taxes. With direct tax, like income tax, individuals and organizations pay the government directly based on their earnings or revenue. Indirect taxes are levied on the sales of goods and services and paid for by the customer through the business. The business then pays (remits) the tax collected to the appropriate tax authority.
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 tax levied is a percentage of the cost to purchase. 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. Unique from other types of indirect taxes, sales tax 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.
When to collect indirect taxes
In general, you are required to collect indirect taxes wherever you make sales, 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 appropriately registered with the tax authorities in the area. 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 with which you file a return may also vary. In the US, large companies with a higher tax liability will often file more frequently (monthly), and smaller companies might only be required to file bimonthly or quarterly returns. 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.