Chapter 5: Sales Tax Flashcards
What is sales tax?
Tax authorities or governments impose a sales tax. A sales tax percentage is charged on goods and services bought or sold and later paid to the tax authorities.
Sales tax may be known under different names
- In the European Union, sales tax is known as Value-Added Tax (VAT)
- In other countries such as India and Australia, it is known as Goods and Services Tax (GST)
Sources of Information
Information on sales tax requirements is usually available through the government’s customs department, which is responsible for collecting the tax. This information, including guidance on the various aspects of value-added tax, is published for public reference.
For example, the Revenue and Customs (HMRC) department is responsible for collecting VAT. The necessary information needed to register for, collect, and pay VAT correctly is available on their website.
Types of Taxable Supplies
Sales tax may only apply to some types of sales in a business. Some supplies are exempted and outside the scope of sales tax.
- Taxable supplies – supplies of goods and services subject to sales tax.
- Exempt supplies – Exempt supplies are goods and services that are not charged sales tax and are not reclaimed on purchases. In the UK, exempt supplies include banking services and education.
- Outside the scope of sales tax – These transactions are not part of the trading activity as they do not create inputs or outputs. This includes wages and salaries.
Registration Requirement for Sales Tax
A business registers with the tax authorities in their country to operate as a sales tax collecting agent for the government. The business (agent) charges tax on sales and reclaims tax on purchases.
Non-registered businesses are not allowed to collect or reclaim sales tax. Similarly, non-registered business customers will pay the full amount and cannot reclaim the sales tax paid.
In most countries, businesses are required to be sales tax-registered when their sales amount or number of sales transactions in a year reaches a specific threshold. In certain countries, businesses may even voluntarily apply for sales tax registration.
For example, a plumber is registered to pay sales tax. He will charge sales tax to his customers and reclaim sales tax on his purchases.
Output and Input Tax
** When output tax exceeds input tax, sales tax is PAYABLE to the tax authorities
Where input tax exceeds output tax, sales tax is RECLAIMED from the tax authorities
- OUTPUT TAX is sales tax charged on SALES TO CUSTOMERS
- INPUT tax is sales tax charged on PURCHASES FROM SUPPLIERS
- NET SALES TAX is calculated as the DIFFERENCE between the OUTPUT AND INPUT TAX. The net sales tax is paid to or received from the authorities regularly (usually monthly or quarterly).
Records Maintained for Sales Tax
When a business is registered for sales tax, the tax authorities will insist that documentation and records be maintained and that administrative rules be followed.
Sales and purchases information mainly, the sales invoices need to be kept for a minimum period as stated by tax authorities to support sales and purchases.
A sales tax invoice is generated with each sale. A copy of the document is given to the customer, and the business retains another.
A valid sales tax invoice should be obtained by suppliers so that sales tax-registered businesses may reclaim the sales tax charged on the purchases made.
1.4.1 Elements of a Sales Tax Invoice
Header – contains seller’s name and address
Sales tax registration number – the business’s unique registration number obtained from tax authorities
Invoice number – the unique invoice number code for the sale transaction
Invoice date – the date the invoice is prepared
Customer address – customer’s address is included for delivery purposes
Description – a description of the goods or services supplied is listed
Sales Tax Amount – the sales tax charged on the sale
Payment Terms – the credit terms given to the credit customer are stated
Sales Tax Accounting Schemes
Gov depts that collect sales tax may allow several different methods to account for sales tax.
For example in the UK, there are several accounting schemes available:
- Annual accounting scheme – submit VAT returns and make payment four times a year.
- Cash accounting scheme – pay and claim VAT as payments and receipts occur.
- Flat rate scheme – pay a flat annual amount as VAT, and retain the VAT recovered from customers (no VAT claims on purchases).
- Margin scheme – VAT is charged on the difference between the purchase and selling price of an item.
- Retails schemes – amount of VAT is recorded in accounts and calculated when submitted the VAT return.
Sales Tax Transaction Amount
- The net amount is the sale or purchase price before sales tax. The net amount is ALWAYS 100%.
The gross figure is the sale or purchase price, including sales tax. It is always 100% + Sales Tax %
Exam - The sales tax rate on sales and purchases varies from country to country and is provided in the FA2 examination.
Trade Discounts
Trade discounts are guaranteed list price reductions that are not conditional on an event’s occurrence. Businesses offer them to encourage bulk purchases or foster deeper customer relations.
Trade discounts are deducted from the price charged, and the sales tax will be calculated on the AFTER-DISCOUNT AMOUNT.
effect of change in Sales Tax Rate
Sales tax rates are determined by local tax authorities and are subject to updates occasionally. A change in sales tax rate will affect a business:
Cash Flow
Output tax charged on sales to customers will change. Suppose the business pays sales tax to the authorities before the customers settle the amounts due. If the sales tax rate increases, the business may need to arrange an overdraft to cover the shortfall until the customers pay.
Customers
Customers who are registered for sales tax will be aware of the changes. If they are not, the business will need to inform them that the prices charged will rise.
Accounting System
The change in the sales tax rate needs to be printed on the sales invoices. The computerised accounting system needs to be updated to reflect the change.
Sales and Sales Returns with Sales Tax
Credit and Cash Sales
A credit sale arises from a sale to a customer for future payment. For credit sales incorporating sales tax, the amount attributable to sales tax is recorded as output tax in the Sales Tax account.
In a typical credit sale with sales tax, three ledger accounts are affected:
- Trade Receivables (DR, receivables (asset) increased)
- Sales (CR, sales (income) increased
- Sales Tax, Cr, (output), taxes to authorities (liability) increased
The amount entered into the Sales account is the net amount (price after including the trade discount).
In a typical cash sale with sales tax, three ledger accounts are affected:
- Cash/Bank: DR, cash/bank asset increased
- Sales: CR, sales income increased
- Sales Tax: CR, taxes to authorities (liability) increased
Sales Returns
Sale returns are goods returned to the business by the customers due to an error on the business’s part, such as delivering damaged or incorrect items.
A sale return transaction with sales tax will impact three ledger accounts:
- Sales Return: DR, sales refunds (expense) increased
- Trade Receivables: DR, sales tax, taxes due to authorities liability decreased
- Sales Tax: CR, Receivables asset decreased
If trade discounts were given, the trade discount needs to be included in the computation of the sales amount.
Purchases and Purchase Returns with Sales Tax
Credit Purchase
A credit purchase arises from a purchase from suppliers for future payment. For credit purchases incorporating sales tax, the amount attributable to sales tax is recorded as input tax in the Sales Tax account.
In a typical credit purchase with sales tax, three ledger accounts are affected:
- Purchases (Asset or Expenses)
- Trade Payables
- Sales Tax
(see table}
The amount to be entered into the Purchases or Expense accounts is the net amount (price after trade discount)
