Sales Tax on Invoices: The Basics for Small Businesses
Sales tax is one of those subjects that seems simple until you have to apply it. You add a percentage to the price, collect it and pay it over, right? In reality, whether you charge sales tax, how much and to whom depends on where you operate, what you sell and who you sell it to. This guide explains the basics of sales tax on invoices in plain language. It is general information only, so confirm the rules for your location with a qualified tax professional.
What Is Sales Tax?
Sales tax is a tax charged on the sale of certain goods and services, typically collected by the seller at the point of sale and passed on to the government. In places that use it, such as the United States and Canada's provincial systems, the tax is generally intended to fall on the final customer rather than on businesses that resell the goods.
It differs from VAT and GST in an important way. Under a classic sales tax system, tax is charged only on the final sale, and sellers collect it from the customer without the stage-by-stage credit system that VAT uses. Many places also have layered rates, with a state or provincial rate plus local rates added on top. If you want to compare systems, see our articles on VAT and GST.
Do You Need to Collect It?
Whether you must charge sales tax depends on a handful of factors. The most important are listed below.
- What you sell. Some jurisdictions tax physical goods but not services. Others tax certain services, such as software or digital products, and exempt basic necessities.
- Where you and your customer are. Rules may depend on your location, your customer's location, or both.
- Your connection to a place. Having a physical presence, employees or a certain level of sales in a region can create an obligation to collect tax there. This is often called nexus or a similar term.
- Who the customer is. Sales to certain customers, such as resellers or tax-exempt organisations, may not be taxable if they provide the correct documentation.
Watch out: The rules for online and cross-border sales have changed in many places and continue to evolve. Do not assume that a rule you learned several years ago still applies. Always verify current requirements.
How to Show Sales Tax on an Invoice
When tax applies, the invoice should make it easy to see what was charged and why. A clear layout includes the price before tax, the tax rate or rates, the tax amount and the total. Separating the tax from the price is good practice because it lets your customer and your accountant see exactly what you collected.
| Description | Quantity | Rate | Amount |
|---|---|---|---|
| Printed brochures (taxable) | 200 | 2.00 | 400.00 |
| Design service (non-taxable in this example) | 1 | 300.00 | 300.00 |
| Subtotal | 700.00 | ||
| Sales tax on taxable items (8 percent of 400.00) | 32.00 | ||
| Total due | 732.00 | ||
The rates and taxability in this example are illustrative only. In real life, whether design services are taxable, and at what rate, depends on your location.
Tip: If only some of your items are taxable, apply tax to those lines only. Our invoice generator lets you set a tax percentage per line item, so mixed invoices are easy to build.
Calculating Sales Tax Correctly
Calculation is usually the easy part, once you know the rate. Multiply the taxable amount by the rate, round according to local rules and add it to the total. Two details trip people up.
Combined rates
Where multiple authorities apply tax, you may need to add the rates together or show them separately. If you are unsure which rate applies to a particular customer, ask a tax professional or consult the relevant authority's lookup tool.
Discounts, shipping and fees
Whether discounts reduce the taxable amount, and whether shipping or handling charges are taxable, varies by place. In many systems, a discount applied by the seller reduces the taxable price, while shipping may be taxable if the goods are. Check the rules in your area before deciding how to arrange the lines on your invoice.
Exemptions and Resale Certificates
Some customers do not pay sales tax on their purchases. This might be because they are buying goods to resell, because they are a charity or government body, or because the product is exempt. In such cases, you generally need to keep documentation, for example an exemption or resale certificate, on file to justify not charging tax.
If you do not collect the paperwork, you may be held responsible for the tax later. Make it a habit to request the certificate before you issue the first invoice, and store it with the customer's records. Requirements differ, so ask your tax adviser what to keep.
Records, Reporting and Good Habits
Sales tax must be reported and paid on a schedule set by the authorities. Keep your tax collected separate from your working money so you are never short when payment is due. Save every invoice, along with notes on why tax was or was not charged. For ideas on organising your files, read how to keep invoice records for tax time. If a mistake slips through, correct it with a credit note and a new invoice.
When it comes to tax, a few minutes of checking before you send an invoice is far cheaper than fixing it after an audit.
Good to know: Sales tax law is complicated and changes often. This article gives general background and is not legal or tax advice. Please consult a local tax professional about your own business.
Frequently Asked Questions
Do freelancers need to charge sales tax on services?
It depends on where you are and what the service is. Some places tax services, while others do not. Look up the rules for your location or ask an accountant.
Should I include tax in my listed prices?
In some countries, prices shown to consumers must include tax, while business quotes usually show tax separately. Follow local practice and make it clear on your quotes and invoices.
What if I charged the wrong amount of tax?
Issue a corrected invoice, ideally along with a credit note for the original, and report the right amount to the tax authority. Speak to a professional if the error is large.
Show your totals clearly. Create a free invoice now and add tax to the lines that need it.