Sooner or later anyone who’s thinking about launching a
business faces an issue that causes severe headache – taxes! In this particular
article, we are going to talk about value added tax (VAT).
What is VAT?
Value added tax, or VAT, is a type of tax that is levied on
the value of goods or services added at each stage of production, distribution,
or sale to the end customer (consumer). Also known as the goods and services
tax in some countries, it’s a consumption tax that is paid by the final
consumer who ‘consumes’ products and services, but in practice, VAT is paid at
each stage of the supply chain.
Sounds too complicated? Let me explain it in simple terms.
How does VAT work?
Let’s imagine a supply chain that consists of three stages:
a farmer who grows apples, a food-manufacturing plant that makes apple juice,
and a retail store that sells the juice to end customers. Now let’s get to
numbers.
For simplicity, let’s suppose the farmer only puts his own efforts
into growing apples. He doesn’t buy anything from other businesses. In this
case, he has no expenses and his added value equals the price at which he sells
the apples to the plant. So, if he sells the apples for $100, the VAT is
applied to this sum.
If the value added tax rate is 20%, the farmer will have to
pay $20 to the government. But he doesn’t want to lose money and includes this
sum into his final price which increases to $120.
The food-manufacturing plant buys the apples from the farmer
and pays him $100 + $20 that goes to the government. The plant makes apple
juice and wants to earn $200 as profit (added value). In this case, the plant
will have to pay $40 as VAT.
But the plant has already paid $20 to the farmer, so it
sells the juice for $360: the cost of apples ($100) + the farmer’s VAT ($20) +
the profit ($200) + the plant’s VAT ($40). In this case, $40 goes to the
government, while $20 goes to the plant as compensation for the farmer’s VAT.
Next, the retail store pays $360 for the juice and wants to
make a profit of $400. But it has to pay $80 to the government as VAT and wants
compensation for the plant’s VAT. So, it sells the juice to an end customer for
a total of $840: the cost of juice ($300) + the plant’s VAT ($60) + the store’s
profit ($400) + the store’s VAT ($80).
As for the end buyer, he or she pays $840 for all the juice
bottles including $140 as VAT, but he or she cannot get this sum back.
So, as a result, the customer doesn’t pay the money to the
government. Instead, the businesses in the chain do it. But the end consumer
pays the tax to businesses so that they could hand the money to the government.
The VAT that the customer must pay equals $140. It is the sum of the VAT the
businesses have already paid to the government: $20 + $40 + $80 = $140.
But what about dropshipping? Do you have to pay value added
tax? In most cases, you do.
When you purchase a product from a supplier, the price
already contains VAT he/she pays to its government. So you don’t have to worry
about it. But you must also collect VAT from your customers to compensate for
your expenses and hand the tax to the government.
Let’s take a look at tax systems in the most popular
countries for dropshipping – the UK, the US, and the EU.
Value added tax in the United Kingdom
After the UK left the European Union, its tax regulations
changed. Here’s what you need to know.
If you want to sell products in the UK from overseas, you
have two options. You can either use an online marketplace or sell goods from
your own website.
And since this is the case for dropshipping, you have to
register your business for VAT in HMRC (Her Majesty’s Revenue and Customs). You
can do it online or by post. After that, you’ll get a 9-digit VAT number.
If the cost of the consignment of goods doesn’t exceed £135,
VAT is calculated based on the price at which you sell products to customers.
If the cost exceeds £135, VAT is calculated at the point where the products
cross the border.
The standard VAT rate in the UK equals 20%. But for some
categories of goods, the government applies the reduced rate (5%). Some product
categories are VAT-free. To see the full list of VAT rates in the UK, follow
this link.
You can also read our article on dropshipping in the UK to
learn about other taxes and customs regulations in the kingdom.
Sales tax in the United States
First of all, the government of the United States doesn’t
collect value added tax. Instead, end customers pay sales tax.
It’s a consumption tax imposed on goods and services sold
within a state’s jurisdiction. While VAT is collected at each stage of
production, sales tax is collected only at the final stage (consumption).
Still, from a retailer’s point of view, sales tax is basically the same as VAT.
The problem here is that the federal government doesn’t
collect sales taxes. It is the responsibility of the states. As a result, sales
tax rates are different in each state, and so are the rules (to some extent).
For example, California has the highest sales tax rate
equaling 7.25%, while Delaware imposes no sales taxes at all. You can see all
sales tax rates by state here.
Previously, a business didn’t have to pay sales taxes unless
it ‘had a nexus’ in the given state. To have a nexus means to have a physical
presence in a state: to own a brick-and-mortar store, a warehouse, etc.
However, after the new Supreme Court ruling (South Dakota vs. Wayfair, Inc.), this requirement is no longer in
force.
In simple terms, it means the following. Previously, if your
business didn’t have a large enough presence in a given state and a customer
from this state purchased something from you, you didn’t have to pay the sales
tax. The same goes for businesses registered outside the US.
But now, according to the new ruling, it doesn’t matter
whether you have or have not a nexus in a given state – you do have to pay the
sales tax anyway.
Nevertheless, to collect sales taxes, your business must be
large enough: to have annual sales not less than $100,000 or make not less than
200 separate transactions in a given state per year.
It means that if your dropshipping store receives less than
200 transactions from this particular state and makes not more than $100,000
from this particular state, you don’t have to pay the sales tax to the
government of this state.
But if your business exceeds this limit, you will have to
register your business with the given state’s tax authority. Unfortunately,
each state has its own requirements, so it’s impossible to give a general
recommendation here. Just visit the corresponding state’s website to learn the
details.
Value added tax in the European Union
Goods imported into the EU countries with a value of up to
€10-22 (depending on the country) are exempt from import VAT. But if their
value exceeds this limit, import VAT must be charged.
If your business is located outside the EU, the
responsibility to pay VAT lies on the importer of record. Usually, it is the
end customer. The problem here is that the customer must pay the tax when he or
she receives the parcel. It often becomes a very unpleasant surprise and can
lead to more refunds.
To solve this issue, one can register for VAT in the country
where the products cross the EU border. It’ll make you the importer of goods
liable for collecting and paying VAT. In this case, the consumer will pay the
full price (including import VAT) at the checkout. Or you could just warn
customers that they will be charged with VAT.
But different EU countries have different VAT rates (from
17% to 21%), while some countries exclude mail orders from this exemption. What
if you sell goods to an EU country different from your country of registration?
If your business is registered in the European Union and
sells products to end customers living in another EU country, you apply the VAT
rate of the country where you are registered.
From July 1, 2021, these rules will change. EU and non-EU
businesses importing goods with a value up to €150 will be able to join the
Import One Stop Shop (IOSS) Scheme. It will let you declare and pay VAT in a
single monthly VAT return.
You must collect the tax when accepting the payment for the
goods (i.e. at the checkout). Then you pay it to the country where you
registered your business for the Import IOSS.
Otherwise, the customs broker will collect VAT.
If the imported consignment of goods has a value exceeding
the €150 threshold, import VAT is paid to the customs. It may also require a
regular VAT registration in the country of importation.
The government will replace the old VAT thresholds with a
new uniformed threshold. Small businesses registered in an EU country and
selling less than €10,000 of goods to other EU countries, will be able to
charge domestic VAT. Otherwise, they will charge the VAT rate of the country of
import.
As you can see, the tax system of the EU is probably the most
complicated because each country has its own rules and tax rates. So,
consulting a tax advisor is a must here.