As Canadians, sales tax is something that most of us take for granted as part of our daily lives. However, this all changes the moment you start a business. Once you go from simply paying sales tax to actually collecting and reporting it, there’s a lot more that you’ll need to know. That’s why learning the essentials of GST/HST is one of the first things every business owner should do. We can assume that you’ve taken it upon yourself to seek out some information by the very fact that you are reading this post. So this alone puts you off to a good start. Now let’s dive right in.
How Sales Tax Works
Let’s start off with the very basics. If you feel like you have a good grasp of sales tax, feel free to skip this section.
Businesses have to collect sales tax from customers at the applicable rate, and remit it to the government on a periodic basis. Assuming a tax rate of 13% on a $100 sale, the customer pays a total of $113, of which $100 belongs to the business, and the remaining $13 is to be remitted to the government. The government, in this case, would be the Canada Revenue Agency (CRA).
The business cannot use these funds for its own expenses. At the end of the applicable reporting period (yearly, quarterly, monthly), the business reports the total tax it collected and remits this to the CRA.
Simple enough, right? Keep reading; it gets a tad bit more complicated.
Charging and Paying Sales Tax
Generally, sales tax is collected for any product or service that a business sells (known as taxable supplies), except for certain specific items such as basic groceries (excluding processed food or prepared meals), prescription drugs, medical devices such as hearing aids, and any goods sold for export. Just like your earnings, assume it’s taxable unless specifically excluded.
On the flip side, any sales tax that a business pays for its own expenses can be recovered from the CRA in the form of Input Tax Credits (ITCs). As a result, the business remains in a net tax neutral position, whereby it remits to the CRA all the tax it collects, and it gets back all the taxes it paid.
Let’s look at an example. We’ll assume a sales tax rate of 13%. If, in the first year, you make one sale totaling $100, you will collect $13 in sales tax from your customer which you owe to the CRA. During the same year, if you’ve paid $50 in expenses, you would have paid sales tax of $6.50 on these purchases. When you file your sales tax return for that year, you will owe the government $13 from that sale you made, but you can also collect $6.50 in taxes you paid, for a net amount owing to the CRA of $6.50. Alternatively, if you sold $100 worth of stuff but also bought stuff for $100, you wouldn’t have to pay anything to the CRA.
Similarly, as you ramp up the company, it’s possible that you’ve made no sales in your first year, but instead paid sales tax for all your purchases and expenses. In this case you can of course get back all the sales tax you paid as a refund.
As mentioned before, it’s important to realize that the business is merely acting as an agent in this situation, and any sales tax collected is actually the government’s money that the business is holding on to. This is the reason that the penalties for late payment of sales tax tend to be much higher than those for income tax. The Directors of a corporation can also be personally liable for any unremitted sales taxes.
Sales Tax Components
In Canada, sales tax consists of the Federal portion, known as the Goods & Services Tax (GST), which is charged at a rate of 5%, along with the Provincial Sales Tax (PST), which varies in each province. For example, Alberta has no provincial sales tax, whereas in Nova Scotia, residents pay a PST of 10%.
Some provinces including Ontario and the Atlantic provinces charge the Harmonized Sales Tax (HST), which is a combined tax that includes both the HST of 5% and a PST for each province. For example, Ontario has a PST portion of 8%, for a total HST of 13%.
Businesses need to charge both the GST and the PST, or just the HST where applicable, on most taxable supplies. There are a few exceptions – for example, only the PST is charged when selling insurance.
Do I have to charge sales tax?
If you’re just starting out, you may not need to charge & collect sales tax. Certain smaller businesses are not required to charge sales tax if their sales volume is low. These are known by the CRA as small suppliers.
Businesses are only required to register for GST/HST and start charging sales tax once their total taxable supplies (sales) exceed a combined $30,000 in either the last four consecutive quarters, or if they exceed that amount in a single quarter. Once you pass this threshold, you’re required to register for GST/HST and start collecting sales tax.
Let’s look a couple of examples to understand how this threshold works in each of the two cases. Assume a calendar fiscal year (Jan 1 to Dec 31).
- Your total sales in each quarter of the first year were $8,000, so the total sales for the year are $32,000. At the end of the year, you’ve exceeded the $30,000 limit in the last four quarters, and are no longer a small supplier. The effective date that you cease to become a small supplier is one month after the fourth quarter. In this case, it would be January 31 of your second year. We recommend you register for GST/HST at the this time, and you’ll have to start charging sales tax on all your sales starting February 1 of your second year.
- The total sales in each of the first two quarters were $1,000, but you made a large sale worth $40,000 in the third quarter. Since that big sale pushes you over the limit in that particular quarter, you cease to be a small supplier as of the date of the sale. You need to charge sales tax on that large sale and all subsequent sales, and register with the CRA within 29 days from the date of that sale.
As you can see, keeping track of your sales volume is important to ensure that your GST/HST registration requirements are met. This is where cloud accounting really shines; since your sales data is always in sync, your cloud accountant is able to view your books in real-time and can advise you of when you are over the small supplier threshold. Compare this to traditional bookkeeping where your accountant may not see your books until the end of the first year (or perhaps much, much later), by which time it’ll be too late and you may incur penalties & interest.
One very important thing to note is that if you are not registered for GST/HST, you cannot claim input tax credits on any purchases you make. That means you won’t be able to recover the tax you paid on any large upfront costs in setting up your business. Therefore, it may be in your best interest to register for GST/HST right away. We always recommend registering upon incorporation so that you can start recovering the tax you pay for expenses in the early stages of your business, when your expenses may outweigh your sales.
If you’ve made it this far, we can only assume you’d like to learn more. Stay tuned for Part 2 of our guide, which will cover reporting, payments and instalments.