A country’s government is responsible for undertaking several activities directed towards the welfare of its citizens. From public healthcare to public infrastructure to employment programs, there are a whole host of activities that require the government to incur expenditure. In order to fund expenditures for these activities, governments levy various taxes on both individual citizens and business entities.
A tax is a mandatory levy that is imposed on a taxpayer by the government of the country to fund its various public expenditures. Taxes can take several forms. This article looks at meaning of and difference between two types of tax levies – income tax and sales tax.
Definitions and meanings
Income tax is the tax levied by a government on the income earned by entities. These entities can be individuals, firms, companies or any other entity that has earned a taxable income. Broadly, the income tax is levied on the following type of incomes:
- Income from salary earned by individuals who are employed.
- Profits and gains from business or profession earned by individuals or entities that operate any independent commercial activity.
- Income from house property earned by entities by virtue of their owning property which typically includes rentals.
- Gains from capital assets earned when those assets are sold or otherwise transferred for a consideration.
- Other incomes such as investment income and lottery gains etc.
Income tax is a direct tax. Therefore, levy of this tax and liability to pay it vests with the same person i.e., the person who actually earns the income.
Taxpayers are expected to file annual tax returns wherein they declare their various sources of taxable income and accordingly pay appropriate income tax. In order to exercise an advance collection of income tax, jurisdictions also incorporate withholding tax provisions. For example, companies are expected to deduct tax form the salary of their employees and deposit the same to the credit of the government. Employees normally get credit against these withheld taxes at the time when they file their individual annual income tax returns.
Sales tax is an indirect tax that is levied on sale of goods effected by any entity. The taxable activity here is the sale of goods and the tax is typically levied on individuals or entities who effect sale of goods as a result of their manufacturing or trading activities.
Being an indirect tax, the sales tax is levied on one entity but the ultimate liability to bear the tax amount falls on a different entity. Sales tax is levied on sales realized by the seller but is generally collected from the buyer by way of its inclusion in the sales price of the product sold.
A Ltd sells goods valued at $50,000 to one of its customers, Z Ltd. As per the local laws, sales tax of 5% (i.e., $2,500 = $50,000 x 0.05) is chargeable on the goods dealt in by A Ltd. A Ltd charges Z Ltd. an amount which is inclusive of sales tax i.e., $52,500 ($50,000 + $2,500). The sales tax collected by A Ltd. from Z Ltd is required to be deposited with the government authorities periodically – generally on monthly or quarterly basis.
Difference between income tax and sales tax
Eight key points of difference between income tax and sales tax have been listed below:
- Income tax is a mandatory government levy on various incomes earned by individuals and/or entities.
- Sales tax is a mandatory government levy charged on sale of goods effected by individuals and/or entities engaged in selling activities.
2. Levied on
- Income tax is levied on various incomes such as salary income, business/profession profits, capital gains, rental incomes, investment incomes etc.
- Sales tax is levied only on sale of goods.
- Income tax is a direct tax; both the tax liable entity and the tax paying entity is the same – the income earner.
- Sales tax is an indirect tax – the tax liable entity (seller) and the ultimate tax paying entity (buyer) are different.
4. Regulated by
- Income tax is governed by income tax laws such as Internal Revenue Code in USA and Income tax Act in India etc. It is regulated by income tax authorities such as Internal Revenue Service in USA and Income tax department in India etc.
- Sales tax is governed by separate specific laws related to sales tax. In USA, for example, sales tax is a state subject and is regulated by each state in accordance with its own rules and regulations within the overall constitutional framework.
5. Calculation methodology
- The calculation of income tax is determined by the nature of income as well as the quantum of income earned by the tax payer. Its calculation is generally done on the basis of slab rates which are generally different for different income levels. The sales tax calculation is more complex as it encompasses several types of incomes and considers a number of allowances and disallowances.
- Sales tax is typically charged at a flat rate on the sales value which makes the calculation comparatively simpler.
6. Quantum of charge
- Income tax is usually charged at higher rates as compared to sales tax – typically upward of 10%, increasing with the increasing level of entity’s income.
- Sales tax is typically charged at lower rates – usually below 10%.
7. Collection methodology
- In case of sales tax, taxpayers are required to file returns to self declare and pay the income tax due by them. In addition, the income tax may also be collected by levying withholdings at the point of generation of certain types of income.
- Sales tax is collected by sellers from buyers at the point of sale and deposited periodically with the government as per instructions.
- The scope of income tax levy is considerably wider as it covers all types of income.
- The scope of sales tax levy is narrower as it is only applicable to the transactions of sale of goods.
Conclusion – income tax vs sales tax:
Both income tax and sales tax are among the prominent sources of revenue for a government. The key difference between two is that the former is levied on entities’ income whereas the later is levied on the sale of goods.
Irrespective of the type of tax, governments have the power to audit the correctness of calculation and payment of these taxes. In order to ensure that the taxpayers are correctly paying both income tax and sales tax, tax regulatory bodies of all jurisdictions carry out tax assessments when required. Any discrepancies noted will give rise to tax proceedings being undertaken for recovery of short paid tax amounts, if any.