Introduction - The Excise Tax Act and Classifying Supplies
A GST/HST registrant must collect and remit GST/HST on sales of taxable supplies. The Excise Tax Act provides three classifications for supplies; fully taxable supplies, zero-rated supplies, and exempt supplies. How a supply is classified will determine to what extent a registrant must collect GST/HST, and what input tax credits (ITCs) and refunds that supplier may otherwise be entitled to. Classifying a supply depends on its nature and the scheduled lists of the Excise Tax Act itself. The distinction between expenses as fully taxable, zero-rated or exempt is complicated and essential for most any business engaging in commercial activity. If you are unsure how to classify a particular expense or what GST/HST benefits might be available for your business, then you should contact an expert Canadian tax lawyer.
What is a Taxable Supply?
A "supply" as defined by the Excise Tax Act includes among others any sort of services, sales, transfers, bartering, exchanges, licenses, rentals, leases, gifts and dispositions of property. In other words, supply is the term used by the Excise Tax Act for sales. Under subsection 165(1) of the Excise Tax Act, any purchaser of a 'taxable supply' in Canada must pay GST/HST on the cost of a supply. A 'taxable supply' under Section 123(1) of the Excise Tax Act is a supply that is made in the course of commercial activity that has not otherwise been explicitly re-categorized under the Excise Tax Act. In a very general sense, any supplier of goods or services in the course of business activity or the purchase and sale of real property (including homes, commercial buildings, and land) will be providing a taxable supply.
In Canada, GST/HST is assessed according to the 'invoice-credit' approach. All other things equal, if every producer of supplies in Canada had to pay GST/HST on purchases, then the cost of transactions would exponentially increase. As well, the purpose of GST/HST as a sales tax is to tax the good in the hands of the final consumer. The invoice-credit approach allows for the GST/HST paid by a supplier to be offset by an input tax credit (ITC), which is equal to the GST/HST paid or payable on the supplies purchased by the business. Businesses that consume and produce taxable supplies along that supply's production chain will therefore be entitled to shift the full value of GST/HST onto the final consumer. Where input tax credits in a given tax period exceed GST/HST collected on sales, that registrant will instead be entitled to claim a GST/HST refund. The distinction between a fully taxable supply, a zero-rated supply, and an exempt supply is an important consideration in light of input tax credits.
GST/HST Zero-Rated and Exempt Supplies
A taxable supply can include either a fully taxable supply (taxed at the GST/HST rate applicable in a particular province) or a 'zero-rated' taxable supply. Unlike a fully taxable supply, a zero-rated supply is taxed at a rate of 0%. What qualifies as a zero-rated supply is specifically enumerated under Schedule VI of the Excise Tax Act. The list of zero-rated supplies includes necessities of life that society generally believes should not be subject to sales tax. Zero-rated supplies also include taxable supplies that are being exported from Canada, in order to avoid conflict between Canada's sales tax regime and international tax systems. Common supplies included under the schedule of zero-rated supplies are:
- Prescription drugs;
- Medical devices such as wheelchairs, eye glasses, canes, hospital beds, and artificial limbs;
- Basic groceries;
- Most agricultural and fishing products;
- Goods and services exported from Canada, and;
- Foreign travel and transportation services.
An exempt supply, in contrast, is not taxed at any sales tax rate. An exempt supply does not permit a person providing that supply to collect GST/HST on sale. Exempt supplies are included under Schedule V of the Excise Tax Act. Exempt supplies generally include services that society at large would consider inappropriate to tax. Examples included under Schedule V of the Excise Tax Act include, but are not limited to:
- Basic health care and dental services for necessary operations;
- Financial services provided to Canadian residents that are not zero-rated services;
- The sale of used residential housing and long-term residential rents;
- Most land sold by individuals where the land was not used in a business;
- Educational courses leading to certificates or diplomas, tutoring for credit courses, and music lessons;
- Child or personal care services;
- Services provided by charities, not-for-profit, and government organizations.
The Crucial Differences Between Zero-Rated and Exempt Supplies
The practical distinction for the consumer between exempt and zero-rated supplies may seem insignificant. For the final consumer of a good or service, it nominally is. However, the distinction is crucial for producers.
A zero-rated supply is still, by definition, a taxable supply. This allows providers of zero-rated supplies to recover the GST/HST paid as input tax credits. A baker or a butcher, for example, will not be required to collect GST/HST on sales but will nevertheless be entitled to collect input tax credits when filing a GST/HST return for any GST/HST spent on supplies. In contrast, a provider of exempt supplies will not be eligible to claim any input tax credits. This can complicate business for certain industries such as healthcare services. The purchases made and expenses incurred by a doctor to operate a medical practice may not be eligible for input tax credits. This represents a substantial, and often-times hidden, cost for certain businesses.
Where a provider is involved in making a combination of fully taxable supplies, zero-rated supplies and exempt supplies, the record-keeping costs of the business will increase. A retail store, for example, may distribute zero-rated supplies in the form of basic groceries while also selling fully taxable consumer goods like clothing or sporting goods. rated supplies, that provider must diligently account for what supplies were purchased and used. The CRA may disallow an input tax credit claimed where adequate books and records have not been maintained to support the actual nature of input supplies.
Pro Tax Tip: GST/HST Reporting Requirements for Zero-Rated Supplies
One important consideration is that the reporting requirements for providers of zero-rated supplies will generally be higher than providers of exempt supplies. Even though no GST/HST is collected on sale of a zero-rated supply, that sale is still by definition 'taxable.' Revenue from selling zero-rated supplies is automatically included as part of determining the threshold for GST/HST reporting requirements. In contrast, an exempt supply is excluded from sales for the purpose of triggering GST/HST reporting requirements. Even though a provider of zero-rated supplies will not collect any GST/HST, the onerous requirements of filing GST/HST returns may still exist.
The Excise Tax Act and schedules of both exempt supplies and zero-rated supplies are complicated legal instruments. If you are interested in tax planning opportunities that may exist for your business, or your reporting requirements as a supplier, you should contact an expert Canadian tax lawyer to discuss this.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.