What is the difference between sales tax and value added tax?

1. Value Added Tax – a definition
2. Sales Tax – a Definition
3. The Small Business Regulation
4. Tools and Further procedure
5. Conclusion - from theory into practice:

Long Story Short - In Germany, there is basically no difference between sales tax and value added tax. The sales tax is a term defined in national tax law - the term value added tax here is rather of a colloquial nature.

However, the term value-added tax still has its right to exist, if you want to be exact. For example, the term is used in the context of the Value Added Tax Act (VAT Act) in Switzerland or Europe-wide in the so-called Value Added Tax System Directive (VATsystrl). The latter is important to set and harmonize Europe-wide standards in the context of value added tax, sales tax, VAT regulations etc.

Following is a brief overview of how many tax rates there are:

Value Added Tax – a definition

Where does the term come from?

As the term correctly suggests, it is about the so-called added value. The idea is to tax the added value of a thing. Confused? Completely understandable!

A practical example - here we translate the added value into reality:

In the OMR Reviews brewery, a beer is produced. It costs 50 cents to buy. For distribution, the brewery turns to a beverage wholesaler, who gratefully buys the beer for 80 cents.

So, the beverage wholesaler buys the beer for 80 cents. Now he sells it again for 1 EUR to a kiosk. The profit for the beverage wholesaler is therefore 20 cent. The wholesaler must tax only the added value - in this case, only the 20 cent profit.

That went too fast? No worries - here is the detailed version again:

Before a beer is sold from the „Büdchen“ at 11:11 am on 11.11. in Cologne, a lot has to happen: some brewery in Cologne buys the ingredients for making this drink, this is then processed, turned into beer, sold to a wholesaler and delivered to the beer stall owner. This brew is then chilled and sold at the above mentioned date and time to a drunk ”Jek“, dressed in a penguin costume.

So far so good? Then let's delve a little deeper. The wholesaler buys the Kölsch from the brewery for 80 cents and sells it in turn for 1 EUR to the beer stall. The wholesaler only has to tax the difference to the purchase price (i.e. 20 cents) as added value.

The beer stall finally sells the beer to the end consumer, the ”Jek“ in the penguin costume, who pays 1.50 EUR for it. The beer stall thus makes 50 cents profit. The tax that would now be due on this would be slightly less than 10 cents.

Thus, only the value extracted from the product is skimmed off by the treasury, i.e. the state (as owner of the national assets). Following the motto ”In the end, the duck gets fat“, the end consumer now taxes the entire value added - i.e. taxes on the 1.50 EUR.

Sales Tax – a Definition

As the sales tax correctly states, this is where the turnover is taxed. This means that the wholesaler sells the beer to the beer stall for 1 euro and has to pay 19 cents to the treasury (current sales tax rate of 19 %). But he has already bought goods for 80 cents and is now taxing the entire value of the goods including the purchase? In principle, this would be unfair to the subsequent participants in the value chain.

For this reason, there is a powerful counterpart called VAT! The VAT is the equivalent of the sales tax and entitles the purchasing entrepreneur to claim the VAT on the purchased goods again. The VAT can be pulled because it works like a kind of credit - for the sales tax that you have already paid to the tax office when purchasing goods or services. In our case, this is the sales tax that the wholesaler paid to the brewery when purchasing the beer. The purchasing entrepreneur in our case is the wholesaler. He is now entitled to deduct VAT. The regulation of the VAT works just like the system of VAT, only solved „the other way round“.

In principle, all participants in our example (the brewery / the wholesaler / the booth owner) are entrepreneurs. The end consumer alone does not represent an entrepreneur. This is important in that you always have to check some requirements when a so-called ”entrepreneur“ is involved in order to be able to pay VAT at all, or to be able to claim VAT in each case.   

Following is a brief summary that correctly reflects most cases in national sales tax law for domestic sales:

Each turnover is first of all considered individually. The question to be clarified is whether taxes are incurred on the corresponding turnover at all.

In the following cases, sales tax always applies:

• Delivery of items and goods within Germany
• When providing services within Germany

The question you need to ask yourself is whether the sale comes from the domestic market and whether it is a delivery or other service, a fee is charged for it etc. In practice, this is usually the case.

Once these points are clarified, it is checked whether the turnover might be tax free.

In following cases the turnover is tax free:

• Certain services in the health sector (usually statutory health insurance services)
• Exports abroad
• Certain services in education and upbringing.

If all the previous circumstances have arisen, the sales tax must be paid accordingly.

Now remains the question of how high your assessment basis for the payment of sales tax is. This is the net value of your delivery or service. In the course of the advance sales tax declaration this then becomes due on the tenth of the following month. An advance sales tax declaration is a prepayment that the entrepreneur has to report and pay to the tax office for the taxable services or deliveries provided. At the end of the year, an annual declaration is made, which once again checks whether all sales were declared correctly. If the entrepreneur still needs more time to have all documents ready by the end of the month, he or she can also apply for a permanent extension of time which allows the sales tax to be paid two months later, in the following year. This permanent extension of time is not free of charge. For this “service” a special advance payment is to be made in addition to the advance payments of sales tax. The advance payment is made to allow one month more time to prepare the sales tax declaration.

Practical tip:

The so-called accrual tax is initially decisive for beginners in tax law.

An Example:

Let's assume that you generated 10,000 EUR of net sales in January (bills issued). If you have provided a taxable service or delivery at a tax rate of 19 %, then you have to pay 1,900 EUR on the 10th of the following month. This assumption of 1,900 EUR was made if your sales are subject to the 19 % tax rate.

But if you don't have money in your account yet, it can actually cause liquidity problems. Therefore, it is sometimes advisable to start with the so-called ACTUAL taxation. This means that you only have to pay sales tax on the collected fees. This means that you get the money into your bank account and then you have to pay it only in the next month. This is an important tip for all those who are just about to start their business.

The Small Business Regulation

Under the conditions of the small business regulation there is no value added tax. Naturally, a tax deduction is also not permissible. This makes sense especially for businesses that are just starting their entrepreneurial journey.

You can apply for the small business regulation if your turnover in the preceding financial year does not exceed 22,000 EUR and 50,000 EUR in the current financial year.

Attention here: Just because you may be exempt from VAT as a result of the sales tax rules (small business regulation) - does not mean that you do not have to pay taxes! Therefore always consult the tax advisor of your trust.

Practical tip

When you set up a business, you receive a questionnaire for tax registration. In this, it is asked if the conditions of a small business proprietorship exist (query of the turnover). If you decide on the small business regulation, you can choose this here. The great advantage of the regulation is that especially with small turnovers all the bureaucracy does not rest on your shoulders. The payment of sales tax is carried out in initial short-term periods.

But caution: Submitting a sales tax advance declaration is a big issue with a lot of potential for error, if you are not trained in the subject.

Very important: Also pay attention to the sales tax ALWAYS on all invoices during the use of the small business regulation. If you do NOT show sales tax on your invoices, this legally leads to the fact that you are obliged to pay the sales tax despite using the regulation.

Tools and Further procedure

Moreover, it is essential to acquire invoice programs that can fully support you in the correct issuing of an invoice, as well as in the correct preparation of the incoming invoices for the tax accountant and or for the declaration. For this we gladly provide you with a suitable software guide, which deals extensively with the current software market of invoice programs and the advantages and disadvantages of the individual tools. Here, for example, really good tools are examined more closely, like

WISO MeinBüro Desktop

orgaMAX Buchhaltung

Sage 50 Connected

sevdesk

Lexoffice

FastBill

Pleo

Payhawk

Most tools have guardrails, especially for the ”sales tax jungle“, that help you create proper invoices that go smoothly through the tax office in case of a review and ensure that no annoying inquiries from your customers come. With some programs, you can even create advance sales tax declarations directly.

Conclusion - from theory into practice:

Sales tax is an exciting field in theory, but just as fraught with uncertainties in practice. Take care early on, if you want or have to pay sales tax, to find a qualified tax consultant, who can support you. Because: this topic has a high risk of error and a second look never hurts here!