Introduction – Zero-rated vs. Exempt Supplies
There are three main classifications of supplies in the Excise Tax Act: taxable supplies, zero-rated supplies and exempt supplies. “Supply” for the purposes of GST/HST refers to products or services that are produced by businesses and provided to end users by any means whatsoever, in other words sales of goods or services. This article will focus on the distinction between zero-rated supplies and exempt supplies and the tax implications of each as well as tax planning opportunities that arise. The producers of zero-rated supplies do not have to collect GST or HST on the products or services they sell, but are entitled to benefits in the form of input tax credits (“ITCs”) for GST or HST incurred in the production of the Zero-rated supply. Meanwhile, the producers of exempt supplies are, as the name suggests, entirely exempt from GST/HST reporting and remitting, but are not able to claim ITCs for any GST/HST spent during the production of the exempt supply. The current GST/HST system is complicated and places significant reporting and remittance obligations on sole proprietors, SMEs and corporations alike. In order to survive and thrive in the GST/HST system, it is imperative that businesses understand how they are classified according to the Excise Tax Act. Our top Canadian GST/HST tax lawyers encounter GST/HST problems on a daily basis and can provide practical advice to ensure your business makes use of all available GST/HST benefits in the Excise Tax Act.
Zero-rated Supplies and Input Tax Credits
“Zero-rated supply” is defined in subsection 123(1) of the Excise Tax Act as “a supply included in Schedule VI”. Schedule VI lists numerous products or services, broken down into several categories, including prescription drugs or biologicals, medical assistive devices, feminine hygiene products, basic groceries, agriculture and fishing, exports, transportation services and financial services. The rationale behind each of the aforementioned classifications are numerous, however it is clear that each category describes certain products and/or services, the development of which society generally wants to encourage. In order to understand the tax benefits associated with zero-rated supplies, additional explanation of the Excise Tax Act is required.
The general taxation provision in the Excise Tax Act is subsection 165(1), which says that GST/HST is payable by the recipient, usually the consumer, of a taxable supply at the applicable provincial tax rate. In other words the end purchaser of goods or services has to pay GST/HST. Subsection 165(3) states that the “tax rate in respect of a taxable supply that is a zero-rated supply is 0%”, which in plain English means that zero-rated supplies are a subset of taxable supplies and all of the rules related to taxable supplies are applicable. “Taxable supply” is defined in subsection 123(1) as “a supply that is made in the course of a commercial activity” and “commercial activity” is defined broadly in that same subsection to essentially include any business or concern in the nature of trade carried on for profit, but the definition specifically excludes activities that involve the provision of “exempt supplies”. These provisions, when read together, make it clear that a business operation that produces zero-rated supplies is a commercial activity.
The classification of zero-rated supplies as commercial activities presents the opportunity for tax planning benefits. Section 169 of the Excise Tax Act allows for GST/HST registrants to claim input tax credits for all GST/HST paid by the registrant, to the extent that the GST/HST was incurred to make a supply in the course of their commercial activities. In other words, the producer of a zero-rated supply is entitled to a refund of all GST/HST spent on the goods and/or services that went into the making of the zero-rated supply. Therefore, despite the fact that a business which involves, for example, the production and sale of bread does not have to collect GST/HST on bread sales, the business is still entitled to claim ITCs on their GST/HST return for GST/HST spent by the business on the inputs (purchases of supplies and services) necessary to produce the bread.
“Exempt Supply” is defined in subsection 123(1) of the Excise Tax Act as “a supply included in Schedule V”. Schedule V lists health care services, education services, child and personal care services, legal aid services, charitable supplies, public sector bodies, financial services not included in Schedule VI, ferry, road or bridge tolls, in addition to certain supplies involving real property. Other than real property, the supplies in Schedule V are services involving a human aspect that are considered inappropriate to tax in our society.
While businesses that produce exempt supplies or services are excused from having to collect and remit GST/HST, and all compliance costs associated thereto, there are potential downsides. Producers of exempt supplies cannot receive refunds for input tax credits for GST/HST spent in the course of producing the exempt supply due to the fact that commercial activity is defined in the Excise Tax Act to specifically exclude exempt supplies. Therefore, a doctor who incurs expenses renovating commercial real estate in which to operate the medical practice will not be eligible for ITCs for GST/HST spent during the renovations, which could easily amount to tens of thousands of dollars.
It is also possible for businesses to involve the provision of all 3 of taxable, zero-rated and exempt supplies, which necessitates the need for very detailed record-keeping. For example, health care services provided by an optometrist are an exempt supply, however prescription eyewear or contact lenses that may be sold by the optometrist’s business are zero-rated supplies, and non-prescription sunglasses are normal taxable supplies on which GST/HST must be collected and remitted to CRA.
Zero-rated and Exempt Supplies
In order for businesses to reap all available benefits in the Excise Tax Act, while also ensuring that all GST/HST obligations are continuously met, an understanding of how a given business is classified within the current GST/HST regime is essential. Businesses that produce zero-rated supplies are eligible to claim ITCs for GST/HST incurred in the production of the zero-rated supply. Producers of exempt supplies are excused from the reporting obligations associated with taxable supplies, but are unable to claim input tax credits for GST/HST incurred in their exempt operations, but are still required to report and remit if they also produce taxable supplies or if they produce zero-rated supplies and want to claim ITCs related to those supplies. Speak with one of our Canadian GST/HST tax lawyers to discuss your business operation, identify its classification(s) under the Excise Tax Act and determine whether any tax planning opportunities exist.