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How To Calculate Tax For eCommerce Business (A Beginner’s Guide)

WRITTEN BY
Timothy Shim
UPDATED
May 25, 2024

 

The world of eCommerce has grown tremendously in recent years, with more and more people opting to purchase products and services online. While this has opened up new business opportunities, it has created new challenges, especially regarding tax calculation and rates.

 

It’s essential to understand that tax laws can be complex and vary depending on the location of the business and the customer.

 

 

This article aims to provide a beginner’s guide to tax calculation and tax rates for eCommerce, covering the basics of sales tax, value-added tax (VAT), and goods and services tax (GST).

 

What Is Sales Tax?

 

sales tax

Sales tax is collected by the seller at the point of sale.

 

Sales tax is a tax levied on the government’s sale of goods and services. It is typically a percentage of the total sale price, and it is collected by the seller and remitted to the government.

 

Sales tax rates vary depending on the location of the business and the customer. In the United States, for example, sales tax is levied by state and local governments, and rates can vary from 0% to over 10%.

 

Sales tax is typically levied on the final sale price of the product or service, including any shipping and handling charges. In some cases, exemptions may apply, such as for certain types of products or services or certain types of customers, such as nonprofit organizations or government agencies.

 

How to calculate sales tax for eCommerce

 

Sales tax is calculated by multiplying the sale price by the tax rate. For example, if a product costs $100 and the tax rate is 8%, the sales tax would be $8, for $108. The tax rate can vary depending on the location of the business and the customer.

 

In some cases, multiple tax rates may apply, such as for products subject to state and local taxes.

 

Businesses must determine the tax rate based on the customer’s location to calculate the correct sales tax for each transaction. This can be challenging for eCommerce businesses, as customers may be located in different states or countries.

 

Many eCommerce platforms and payment providers offer built-in tax calculation tools that automatically calculate the correct tax rate for each transaction based on the customer’s location to simplify the process.

 

Pros of sales tax

  • Sales tax is relatively simple to understand and implement, as it is only levied on the final sale price of the product or service.
  • The state or local government typically sets sales tax rates, so businesses don’t have to worry about calculating the correct rate for each transaction.
  • Sales tax is only levied on transactions within a particular jurisdiction, so businesses don’t have to comply with tax laws in other states or countries.

 

Cons of sales tax

  • Sales tax can vary widely between states and local jurisdictions, making compliance challenging for businesses operating in multiple locations.
  • Sales tax exemptions and other rules can be complex, and businesses must comply with all applicable laws.
  • Sales tax is only levied on the final sale price, which means businesses may not be able to recover taxes paid on inputs or other costs.

 

 

What Is Value-Added Tax (VAT)

 

Value Added Tax (VAT)

VAT is added to a product or service at each stage of production and distribution.

 

Value-added tax (VAT) is a tax levied on the value added at each production stage and distribution of goods and services.

 

Unlike sales tax, which is only levied on the final sale price, VAT is levied on each stage of the supply chain, from the manufacturer to the distributor to the retailer. VAT rates can vary depending on the location of the business and the type of product or service being sold.

 

VAT is used in many countries worldwide, including in the European Union, where it is the primary form of consumption tax. In the EU, VAT rates vary from 0% to 27%, depending on the country and the product or service type.

 

How to calculate VAT

 

VAT is calculated by multiplying the value added at each stage of the supply chain by the VAT rate. For example, if a manufacturer adds $10 of value to a product and the VAT rate is 20%, the VAT would be $2, for a total of $12.

 

The same process is repeated for each stage of the supply chain, with the VAT being passed on to the end consumer.

 

To calculate the correct VAT for each transaction, businesses must determine the appropriate VAT rate based on the location of the customer and the type of product or service being sold. Like with sales tax, many eCommerce platforms and payment providers offer built-in VAT calculation tools that automatically calculate the correct VAT rate for each transaction.

 

Pros of VAT

  • VAT is designed to be more comprehensive than sales tax, as it is levied on each stage of the supply chain, from the manufacturer to the distributor to the retailer.
  • VAT can be more efficient than sales tax, as it encourages businesses to keep track of their inputs and claim back the VAT they paid on those inputs.
  • VAT is used in many countries worldwide, which can make compliance easier for businesses that operate globally.

 

Cons of VAT

  • VAT can be complex to implement, as it requires businesses to keep track of the VAT they paid on inputs and calculate the correct VAT rate for each transaction.
  • VAT rates can vary widely between countries and even between different products or services, making compliance challenging for businesses operating in multiple locations.
  • VAT can be more burdensome for small businesses that don’t have the resources to keep track of their inputs and claim back the VAT they paid.

 

 

What Is Goods And Services Tax (GST)

 

Goods and Services Tax (GST)

GST is a tax on goods and services collected at each stage of production and distribution.

 

Goods and services tax (GST) is a tax levied on the supply of goods and services in many countries worldwide, including Canada, Australia, and New Zealand. Like VAT, GST is a consumption tax levied on each stage of the supply chain, with the tax ultimately passed on to the end consumer.

 

GST rates vary depending on the business’s location and the product or service being sold.

 

How to calculate GST

 

GST is calculated in the same way as VAT, by multiplying the value added at each stage of the supply chain by the GST rate. For example, if a manufacturer adds $10 of value to a product and the GST rate is 10%, the GST would be $1, for a total of $11.

 

The same process is repeated for each stage of the supply chain, with the GST being passed on to the end consumer.

 

To calculate the correct GST for each transaction, businesses must determine the appropriate GST rate based on the location of the customer and the type of product or service being sold.

 

Like with sales tax and VAT, many eCommerce platforms and payment providers offer built-in GST calculation tools that automatically calculate the correct GST rate for each transaction.

 

Pros of GST

  • GST is similar to VAT in that it is a comprehensive tax levied on each stage of the supply chain.
  • GST is used in many countries worldwide, including Canada, Australia, and New Zealand.
  • Like VAT, GST encourages businesses to keep track of their inputs and claim back the GST they paid.

 

Cons of GST

  • GST can be complex to implement, as it requires businesses to keep track of the GST they paid on inputs and calculate the correct GST rate for each transaction.
  • GST rates can vary widely between countries and even between different products or services, making compliance challenging for businesses that operate in multiple locations.

 

 

Choosing the Right Tax System for Your eCommerce Business

 

sales tax by state

There are very few standardized tax systems even within countries.
(Source: World Population Review)

 

When choosing the right tax system for your eCommerce business, there are several factors to consider:

 

  1. Location of your customers
    Where are your customers located? If you primarily sell to customers in the United States, then a sales tax system may be the best choice. If you sell globally, then VAT or GST may be more appropriate.
  2. Product or service type
    What type of product or service do you sell? Certain products or services may be exempt from sales tax or subject to different tax rates under VAT or GST. It’s important to understand the tax laws in your jurisdiction and how they apply to your business.
  3. Complexity of your region’s tax system
    How complex is the tax system in your jurisdiction? Sales tax is generally simpler to implement than VAT or GST, but it can still be challenging for businesses that operate in multiple locations. VAT and GST are more comprehensive tax systems but can be more complex to implement and comply with.
  4. Resources
    Do you have the resources to comply with the tax system in your jurisdiction? Sales tax may be easier for small businesses to comply with, while VAT and GST may require more resources to keep track of inputs and claim back taxes paid.

 

 

The Role of eCommerce Platform Builders in Tax Calculations

 

Interestingly, some web hosting choices can play a role in eCommerce tax calculations. For example, eCommerce website builders like Wix and Shopify provide various tools and features to help store owners with tax calculations and compliance.

 

1. Shopify

https://www.shopify.com/

 

Shopify

Shopify includes many features such as built-in tax computation.

 

Shopify, for example, offers built-in tax calculation and reporting tools that automatically calculate and collect sales tax for transactions in the United States and Canada.

 

Store owners can set up tax rates based on the location of their customers, and the platform will automatically calculate the tax amount for each transaction.

 

Shopify also provides tax reports that show the tax collected by location, making it easy for store owners to file their tax returns.

 

2. Wix

https://www.wix.com/

 

Wix

Wix provides customers with tools that can help with eCommerce tax calculation.

 

On the other hand, Wix provides a tax calculator tool that helps store owners estimate the taxes they need to collect and pay based on their location and the location of their customers.

 

Store owners can customize their tax rates based on their business needs and the laws in their jurisdiction.

 

Wix also provides tax reports that show the total tax collected and the tax collected by location.

 

Both platforms integrate with third-party tax apps, such as TaxJar and Avalara, which provide more advanced tax calculation and reporting features. These apps can help store owners comply with complex tax laws, such as VAT and GST, and can automatically calculate tax rates based on the location of the customer and the products being sold.

 

In addition to tax calculation tools, Shopify and Wix provide resources and guidance to help store owners understand and comply with tax laws. This includes articles, guides, and support from tax experts.

 

Overall, eCommerce website builders like Wix and Shopify provide a range of tools and features to help store owners with tax calculations and compliance. These tools can save time and resources for store owners and ensure that they follow the tax laws in their jurisdiction.

 

 

Getting eCommerce Tax Calculations Right

 

Tax calculation and tax rates can be complex and confusing for eCommerce businesses, but it’s important to get it right to avoid legal and financial penalties.

 

Sales tax, VAT, and GST are the three most common tax systems used in eCommerce, and each system has its pros and cons. When choosing the right tax system for your eCommerce business, it’s important to consider factors such as location, product or service type, complexity, resources, and eCommerce platform support.

 

Understanding the tax laws in your jurisdiction and choosing the right tax system for your business can help ensure compliance and avoid costly mistakes.