Many developed economies operate a sales tax system. A business must pay sales tax on the goods and services it buys if those goods and services are supplied by a business registered to account for sales tax. This tax is collected by the seller, who then must pay the amounts collected to the tax authorities. In the UK this tax is known as Value Added Tax (VAT), but for the rest of this chapter it will be referred to as sales tax. Prices in shops normally include sales tax, but business-to-business transactions are often quoted excluding sales tax.
Only a business registered to account for sales tax is required to charge tax on its sales. A tax-registered business acts as a tax collector for the government. It pays over the lax levied on its own sales, but it can reclaim the sales tax suffered on its purchases.
A business must register for sales tax when its sales revenue or turnover reaches a specific limit or threshold, or it may be allowed to register voluntarily in some circumstances.
A sales tax registered business collects sales tax on goods sold and pays it to the tax authorities and can reclaim sales tax paid on its own purchases of goods, expenses and non-current assets. Therefore, in most cases, the business usually makes a net payment to the tax authorities.
Taxable supplies are goods and services sold subject to sales tax.
Input tax is sales tax paid to suppliers which is suffered and paid on purchases by a business.
Output tax is sales tax charged on sales by a business and collected on behalf of the tax authority.
Taxable supplies may be chargeable at different rates of sales tax, depending upon their nature. As an example, rates changed in the UK have varied between 5% and 20%. There is normally a 'standard rate' along with a 'reduced rate' for specified products or services such as domestic fuel charges. These vary by country and may change from time to time.
The supply or sale of some products or services may be 'zero-rated' which means that a zero rate of sales tax is applied to the transaction, perhaps on clothing for children. In practical terms, this means that the business can reclaim sales tax suffered and paid on purchases, whilst collecting no sales tax on sales made. It will therefore normally receive refunds of sales tax suffered on purchases.
Exempt activities are those outside the scope of sales tax for, perhaps, banking transaction services and exports.
There may be a need to calculate sales tax from either the gross figure (including tax). or the net figure (excluding tax). Prices quoted in by retailers to domestic customers are normally stated gross, but business-to-business prices are often quoted on a net basis.
All the following examples assume that the rate of sales tax is 20%.
The business must record:
The gross amount receivable from customers-trade receivables are presented gross in the statement of financial position.
The gross amount payable to suppliers-trade payables are presented gross in the statement of financial position.
Income and expenses are presented net of sales tax in the statement of profit or loss
The sales tax collected and owed to the tax authorities is offset against the sales tax suffered on purchases (and therefore recoverable) from the tax authorities. The net amount included in the statement of financial position. For many businesses, this will be a liability in the statement of financial position. If the net position is that more input tax has been suffered, there will be a receivable in the statement of financial position to reflect a refund due.
Most businesses account quarterly for sales tax and are usually required to settle amounts due within a specified time period.
The steps to accounting for tax on this transaction are:
1 The net sale is credited to the sales account, the tax is credited to a sales tax account and finally the total is debited to trade receivables.
$
Net sales 6,000
Tax 1,200
Gross sales 7,200
Sales 6,000
Trade receivables 7,200
Sales tax 1,200
2 The customer pays the gross amount, clearing the debt.
Note that tax is not accounted for when the money is received from the customer. The tax has already been accounted for when the sale was made.
Sales 6,000
Trade receivable 7,200
7,200
Sales tax 1,200
Cash at bank 7,200
(1)
(1)
(2)
(1)
(2)
The steps to accounting for sales tax on this transaction are:
1 The net purchase is debited to the purchases account as normal. Sales tax is debited to the sales tax account. Finally the total is credited to the trade payables account.
S
Net purchase 4,000
Sales tax 800
Invoice total 4,800
Purchases 4,000
Trade payables 4,800
Sales tax 800
2 When the business pays the debt to the supplier the total invoice amount is paid from the bank account and the amount showing as owing in payables is eliminated.
Purchases 4,000 (1)
Sales tax 800 (1)
Trade payables 4,800 (2)
4,800 (1)
Cash at bank 4,800 (2)
As before, sales tax is accounted for when the invoices are recorded, not when the invoices are paid.
If a business is registered to account for sales tax there are documents and records that must be maintained and administration rules to be followed. Depending upon the size and nature of a business, it may need to make quarterly or monthly returns to account for sales tax suffered on (inputs) purchases, which, in principle, can normally be reclaimed or offset against sales tax on (outputs). Also, businesses may be required to account for sales tax on an accruals basis, with many smaller businesses able to account for sales tax on a cash basis. Some very small entities are able to account for sales tax on an annual basis. Most entities now complete their sales tax returns online and make any payment due (or receive refunds) by automated bank transfer.
Records must be kept of all sales and purchases. A sales tax invoice must be created for each sale and retained, with a copy given to the customer.
A business registered for sales tax must have a valid tax invoice from its supplier to be able to reclaim sales tax on purchases made and expenses incurred.
A tax invoice must show:
Seller's name and address
Seller's sales tax registration number
Invoice date
Description of the goods supplied to the customer, price charged together with the rate of sales tax and total sales tax charged.
| Box | Description | Value |
|---|---|---|
| 1 | VAT due in the period on sales and other outputs | 41,593.60 |
| 2 | VAT due in the period on acquisitions from other EU Member States | 3,078.00 |
| 3 | Total VAT due (the sum of boxes 1 and 2) | 44,671.60 |
| 4 | VAT reclaimed in the period on purchases and other inputs, including acquisitions from the EU | 23,215.53 |
| 5 | Net VAT to be paid to HM Revenue & Customs or reclaimed (Difference between boxes 3 and 4) | 21,456.07 |
| 6 | Total value of sales and all other outputs excluding any VAT. Include your box 8 figure | 268,199 |
| 7 | Total value of purchases and all other inputs excluding any VAT. Include your box 9 figure | |
| 8 | Total value of all supplies of goods and related costs, excluding any VAT, to other EU Member States | 43,789 |
| 9 | Total value of all acquisitions of goods and related costs, excluding any VAT, from other EU Member States | 15,390 |
If a sales tax return and/or payment is submitted late the tax authorities, it is possible that the business will be charged a penalty or surcharge. This may be a percentage of the outstanding tax to be paid.
The business may also be charged a penalty or surcharge if there are errors on the return so it is important to retain documentation and to take care to ensure that the information filed is complete and accurate and that it is submitted on time.
If an error or omission is discovered on a tax return which has already been submitted, the tax authorities must be contacted as soon as possible. If the tax authorities discover an error that the business did not make them aware of, the penalties may be significantly higher. The standard sales tax return form usually includes space available to make and explain any corrections required.
If there is a change in the sales tax rate, the scope of the tax or documentation required, the business must be prepared in advance of the date of change. This may include making staff aware of the changes, updating software that produces sales invoices and also the accounting system that processes accounting transactions. This could require a significant degree of planning and application, depending upon the size and nature of the business.
ELEMENTS OF THE FINANCIAL STATEMENTS
State and explain the five elements of the financial statements.
For a suggested answer, see the &aposAnswers&apos section at the end of the book
COMPONENTS OF THE FINANCIAL STATEMENTS
State and explain the components of a set of financial statements.
For a suggested answer, see the &aposAnswers&apos section at the end of the book