Exempt vs Zero-Rated vs Out of Scope: GST/HST Tax Codes

What is the difference between taxable, zero-rated and exempt?

GST/HST puts every sale in one of three categories. The category decides whether you charge tax and whether you can recover the GST/HST on the purchases behind the sale through input tax credits (ITCs). A taxable sale is charged tax at the rate for its province or territory. A zero-rated sale is taxed at 0%: no tax is charged, but it is still a taxable sale. An exempt sale has no GST/HST at all (CRA: type of supply).

A zero-rated sale is zero-rated in every province. Only the rate on other taxable sales changes with the province or territory (CRA: rates).

A case is not simple when one business makes both exempt sales and taxable or zero-rated ones and the credits it can claim are unclear, when sales go to customers outside Canada, or when the return no longer ties to the books. Before recoding anything, gather four things: sales by category, purchases with the code used on each line, your software's tax-code table, and the GST/HST returns already filed for the period.

Why does zero-rated vs exempt change my input tax credits?

Zero-rated sales are taxable sales, so the purchases behind them can carry ITCs. Exempt sales are not taxable, so ITCs on the purchases behind them are generally lost (RC4022).

A business that makes only exempt supplies generally cannot register, so it has no ITCs to claim (RC4022). A business with both exempt and taxable sales can claim ITCs only to the extent its purchases support the taxable sales. For that split, see GST/HST for medical and health clinics.

Two coding traps follow:

• An export coded exempt gives up credits the business could claim.
• An exempt sale coded zero-rated claims credits the business may not be allowed.

Which sales are zero-rated, and which are exempt?

Basic groceries, prescription drugs and exports are zero-rated. Long-term residential rent, most medical and dental services by licensed physicians or dentists done for medical reasons, and most financial services are exempt. The CRA lists these examples (CRA: type of supply):

A product that sounds like a listed item can sit on the other list. The test is the schedules: Schedule V lists exempt supplies and Schedule VI lists zero-rated supplies, including exports in Part V.

What does out of scope mean, and is it a CRA tax category?

Out of scope is not a CRA category. The CRA describes taxable, zero-rated and exempt supplies. Accounting software often uses the label for things GST/HST does not reach, such as what is not a supply at all.

GST/HST applies to a supply: the provision of property or a service. Under the Act's definitions, neither "property" nor "service" includes money, and "service" also excludes what an employee supplies to an employer in the course of employment (section 123). Money moving and employee pay are therefore not supplies, and no category applies to them. A financial service such as lending money is a supply, and it is exempt: see the purchase codes below.

Do not use the out-of-scope code for a real sale just because no tax was charged. Zero-rated, exempt and small-supplier sales are still sales. Each needs its own code, because each affects your credits or your registration test differently.

Which code do I use for wages, owner draws and transfers between accounts?

Use your software's out-of-scope or no-GST/HST code. None of these is property or a service, so none carries GST/HST.

• Wages: what an employee supplies to an employer is outside the definition of a service, and the pay itself is money.
• Owner draws, dividends and transfers between your own accounts: these are money moving, not property or a service.
• Loan principal going in or out: this is also money. The lending itself is an exempt financial service, priced through interest and fees: see the purchase codes below.

An invoice from an independent contractor, or from a company an owner controls, is not wages. It is a purchase of a service, so code it by the tax shown on the invoice and check it against the purchase rules below.

For a corporation, how owner pay is booked has its own guides: recording dividends, the shareholder loan account and business costs paid personally.

Which code do I use on purchases: supplier bills, bank fees and insurance?

On a purchase, the code records what the supplier charged. If the bill shows GST/HST, use a taxable code. The tax is claimable as an ITC only if the ITC rules are met: you are registered, the purchase is for your commercial activities, and the receipt has the required details (CRA: input tax credits). See what a receipt must show. Tax a non-resident supplier charges under the simplified registration system cannot be claimed as an ITC or a rebate: a regular registrant gives that supplier proof of its registration so none is charged (CRA: input tax credits; section 211.17).

If the bill shows no GST/HST, use a no-tax code. The supply may be zero-rated, exempt, performed outside Canada, or made by an unregistered small supplier. For these there is nothing to claim. Most services of financial institutions, such as lending money or operating deposit accounts, are exempt, and so is issuing an insurance policy (CRA: type of supply).

Two purchases are different even when the supplier's bill shows no tax (CRA: imports and exports):

• Imported goods: GST/HST is collected at importation, so it is usually on the customs or broker document, not the supplier's invoice. See GST on imports and customs invoices.
• Services or software from a supplier outside Canada: you may have to self-assess the tax yourself, even if you are not registered. See invoices from foreign suppliers and contractors.

The category of the bill only tells you whether tax was charged. The category of your own sales decides whether you can claim it. A business that elected the Quick Method of accounting cannot claim ITCs on its operating expenses, so most purchase credits drop out of its return; see filing GST/HST and input tax credits.

Which code do I use for sales to customers outside Canada?

A qualifying export is zero-rated. It is not exempt and not out of scope. Goods shipped to an address outside Canada and certain services to a non-resident, but not to an individual while in Canada, can qualify. A registrant can claim ITCs on the purchases behind zero-rated exports (CRA: imports and exports). Certain advisory, professional or consulting services to a non-resident have their own rule and exclusions in Schedule VI, Part V.

A foreign customer alone is not enough. The type of service, the customer's residence and where goods or property are located all matter. A service performed totally outside Canada is different: the supplier does not charge GST/HST on it (CRA: imports and exports). Software may file it as out of scope. Do not code it exempt just because no tax is charged.

Zero-rated exports and sales made outside Canada both count toward the small-supplier test below. Proof and conditions are in charging GST/HST to US customers.

Do I charge tax if I am under the small supplier threshold and not registered?

A small supplier who has not registered does not charge GST/HST (other than on certain taxable supplies of real property) and cannot claim ITCs. Once registered, even by choice, it has to charge and remit GST/HST on its taxable sales (RC4022).

For most businesses, a small supplier has worldwide taxable sales of $30,000 or less in any single calendar quarter and in the last four consecutive calendar quarters (CRA: when to register; section 148). Taxi and commercial ride-sharing drivers must register even if they are small suppliers. See drivers who never registered.

For sales that would otherwise carry tax, use a separate no-tax code, such as "not registered". They are taxable sales, but a small supplier who is not registered does not charge tax on them (section 166). Registration status does not change a sale's category: keep zero-rated and exempt sales on their own codes. The test counts taxable sales, including zero-rated ones and sales made outside Canada, so coding them exempt or out of scope hides how close you are to the limit. Track taxable sales for each calendar quarter and the last four quarters. For associates' sales, the higher limits for charities and public service bodies, timing, and what happens when you pass the limit, see when to register for GST/HST.

How do I match my software's E, Z and out-of-scope codes to the CRA categories?

Software codes are labels the vendor chose, so the same letter can mean different things in different programs. Open the code table and match each code to a CRA category by what it does to the tax amount.

Then confirm three things:

1. Each code stands for one category. A code shared by exempt and out-of-scope lines hides the difference that decides your credits.
2. Zero-rated and exempt codes calculate no tax.
3. Taxable codes calculate tax at the rate for the right province.

How do I spot a sale or purchase coded wrong in my books?

Sort sales and purchases by code and test each code against its category. These are the common red flags:

Then add up sales and tax by code for each reporting period and compare the totals with the return filed for that period. If the return used the Quick Method, expect purchases not to tie. A difference points to the lines that are coded wrong. If the totals will not tie, see GST/HST return does not match the books.

What if I coded sales wrong on a return I already filed?

Fix the books first, then correct the return. How you correct it depends on whether tax was under-reported or credits were missed, and by how much. See correcting a filed GST/HST return, which also covers how far back missed credits can be claimed. If the CRA is already reviewing a return, see GST/HST reviews and audits.

Example

All figures are in Canadian dollars and are illustrative.

A grocery store: zero-rated sales

An Ontario grocery store sells C$100,000 of basic groceries. They are zero-rated, so it charges no tax. It is registered and pays C$1,300 of HST on new shelving. Because the sales are taxable at zero, it can claim the C$1,300 as an ITC if the other ITC rules are met. Chips and soft drinks on the same shelves are taxable and take the HST code. Coding the groceries as exempt would give up the C$1,300.

A tutor: exempt sales

An Ontario tutor earns C$30,000 teaching a course that follows a curriculum designated by a school authority, an exempt supply. She charges no tax. Because she makes only exempt supplies, she generally cannot register. She pays C$5,000 plus C$650 of HST to fit out a tutoring room, and she generally cannot claim the C$650. Her exempt sales also do not count toward the small-supplier test.

A consultant: zero-rated services and wages

An Ontario consultant bills a US company C$40,000 for advisory services performed in Canada, and pays staff C$20,000 in wages. The advisory services are zero-rated if the client is a non-resident and no exclusion applies, such as service on Canadian property. The wages are not a supply, so they take the software's out-of-scope or no-tax code, not the exempt code. The C$40,000 of zero-rated sales still counts toward the $30,000 test, so registration may be required: see when to register for GST/HST.

Different for you?

• Your books mix zero-rated, exempt and out-of-scope lines and the return does not tie, or you sell both exempt and taxable services and are unsure what you can claim: credits depend on how each purchase supports each kind of sale. See GST/HST for medical and health clinics for the split and GST/HST return does not match the books. Testing every code across several periods is bookkeeping work.
• You filed returns with miscoded sales, or the CRA has written: see correcting a filed GST/HST return and GST/HST reviews and audits. Rebuilding the books behind several filed periods is bookkeeping work.
• You sell to customers in the US or elsewhere abroad: see charging GST/HST to US customers.
• You are close to the small-supplier limit, or may have passed it: see when to register for GST/HST.
• You rent out property: residential rent is exempt and commercial rent is generally taxable. See GST/HST on residential property and GST/HST on commercial property.
• A customer says they are "tax exempt": that is a different question from an exempt supply. See no resale certificate in Canada and GST/HST on sales to First Nations.
• You sell in Quebec or a province with PST: those taxes have their own categories. See GST/HST, PST and QST by province.
• Your books are months behind: see catching up on overdue books and bookkeeping help.