Sales Tax vs. VAT, Part 2: Services and Rates

Part 1 of this Sales Tax vs. VAT series looked at the scope of each type of tax; this post examines how the treatment of services and the rates for each tax differ.

In most U.S. jurisdictions, sales tax generally applies to the sale of goods – that is, to “tangible personal property” – unless a specific exemption exists. Services are generally, but not always, exempted from sales and use tax.

Many states have adopted what is referred to as the “True Object Test,” where the sales and use tax determination for a transaction involving both a tangible personal property and a service relates to the “true object,” “real object” or “dominant purpose” of the buyer’s purchases.

Under many VAT rules, services are far more likely to be taxable. This is the case for EU VAT rules, which define taxable services very broadly: the “supply of services,” according to the EU VAT Directive, “shall mean any transaction which does not constitute a supply of goods,” including the obligation not to do something and acting as an intermediary/agent for transactions. Additionally, liability to pay VAT may shift to the recipient of the service to account for VAT through self-assessment.

Sales tax rates and VAT rates also differ significantly. The average combined sales tax rate in the U.S. is 9.6 percent, while the average VAT rate in the EU is 21 percent (19 percent among OECD member countries). Sales tax is a multi-level tax (i.e., a combination of rates posed at state, county, city and special purpose levels), whereas in most cases VAT adheres to a single national rate. This is a major difference, considering more than 10,000 taxing jurisdictions and sales and use tax rates exist in the U.S.

There are, of course, other notable differences (e.g., input credits and exemption) between sales and use tax and VAT on which tax professionals will want to focus as they take on new compliance responsibilities.