Zero Rated Vs Exempt vs Out of Scope Sales Tax Codes in QBO

Hello everyone. Today we're going to talk about the endlessly fascinating topic of sales taxes. And what is the difference between zero rated, out of scope and exempt? And which one do you choose in QuickBooks Online?

So in the Canadian tax code, these are three classifications and they all mean different things. However, the net result for each of these tax codes is that $0 of GST, HST and QST, where applicable, will be added to your invoice or to your expense. So the question becomes which one do you choose and does it matter? So let's talk about what each one means and then I'll take you through a couple of examples. The first one is zero rated. Transactions classified as zero rated are taxable, but at a zero percent tax rate. This means that while no sales tax is charged to the customer, the business can still claim input tax credits, which means they can claim back the sales tax that are paid on expenses. So this is particularly applicable to businesses who provide goods or services to customers in the US or internationally and are similar to goods or services that you would provide in Canada on which you would charge tax. But since international customers do not pay sales tax, you do not have to charge it. So an example of this would be sales of products such as clothing or pretty much any goods that you would charge GST and HST on to your Canadian customers. And additionally it also includes services like IT or marketing or accounting that you bill to international customers, which similarly you would have charged sales tax on if they were to Canadian customers. Out of scope transactions are those to which sales tax in some sense is just simply not applicable. And just to note, because sales tax is not applicable to these transactions, you cannot claim the input tax credits, that is the taxes paid on expenses. So examples of out of scope transactions tend to be transfers, transfers between bank accounts, transfer from your bank account to your credit card account, withdrawals, personal withdrawals from your bank account, or any kind of personal transactions really are out of scope because you are not able to claim sales tax on personal transactions and transfers to and from your shareholder loan account dividends. Those types of transactions are essentially out of scope and the final classification is exempt. And what that means is for exempt transactions there is no sales tax charge.

But unlike zero rated transactions, it is because.

They are not taxable at the source. So they wouldn't be taxable to Canadian clients and they are not taxable to international clients.

Broad examples and common examples of these types of transactions relate to health care, education and financial transactions, but not in all cases. If you do, if you have a business that deals in any of these types of exempt goods or services. You do want to make sure that you're aware of the nuances and what aspects of these transactions might actually be taxable. But that being said, because your transactions are not, your sales are exempt, it also means that you cannot claim the input tax credits, that is the taxes paid on expenses on transactions relating to exempt transactions. So let's take a look at how it works in practice in QuickBooks Online.

So let's go to our bank transactions.

And you'll see here there are some transactions that have already been downloaded and we are going to basically take an example of each. The first thing we're going to look at is a zero rated transaction. So let's say we have this deposit, deposit comes, it's a credit card payment from Intuit. And let's say this sale was made to a international customer, Scotland Yard. They're in, in the uk, we do not charge them sales tax. So we can from the drop down choose what the category is. And we have provided consulting services. So let's choose that. This the tax code that automatically appears here because this is connected to consulting services is HST Ontario. But in this case we are going to choose zero rated on sales. And the reason we're going to say no to this, the reason we're choosing zero rated, because if we had provided consulting services to a Canadian client, we would absolutely have to charge them sales tax. But because they're international, no sales tax is required. They are 0 rated. And 0 rated by extension means we can claim back the sales taxes paid on expenses. We'll leave the location in class blank for now. And this essentially is our transaction. We can add some more complexities when you've downloaded transactions. I would recommend creating an invoice and matching it to the invoice. But it's a subject for another tutorial. So let's click on add and that is our zero rated sale.

Next let's look at something that's out of scope. So a transaction that's out of scope, for example is this. And here we can see this is a transfer from a bank account. So because it's a transfer from a bank account, really sales tax is just not applicable because you wouldn't charge sales tax on a transfer between accounts. So let's take, let's look at the type of transaction. It's a deposit, but you can also record it as a transfer. And the transfer you'll notice in QuickBooks Online actually just completely eliminates the sales tax code. It's not required to select just a note. You can use either one of these. If you were to choose categorize, you could select a payee or not. I'm going to say this goes to the shareholder loan account for Sherlock Holmes and he has deposited some money because he has some cash flow requirements. The tax code now is in this case as discussed. It is out of scope. I prefer, I don't know why they have a sales in a purchases. If it's out of scope, it's out of scope. That's just QuickBooks Online. I prefer to choose out of scope purchases so that it does not impact my sales report. If you choose out of scope sales, it will actually show up as a line item on your customer detail sales report and it will add an amount to sales which doesn't make sense and makes your sales look much higher than they are. So my preference is to choose out of scope purchases for all out of scope type transactions. So you click on that, we're going to say no. You can say yes because pretty much anything in and out of the shareholder loan is probably exempt. But there are exceptions so let's not do that now.

And that's it. You can add a tag or other parts of this if you want. Otherwise you can simply add the transaction.

The third type of transaction we are going to look at is an exempt transaction. So bank charges, which are a fee that is imposed by a financial institution is always exempt. And therefore this is the type of transaction where we will select exempt as the tax code. The payee could be. This comes from td. I could select TD as my supplier. The category is bank charges does not appear here. So I am just going to to add it.

And it is an account type, it is expenses and it is bank charges Save and close that. And we have just added a transaction directly through this interface Customer not applicable here. You can actually toggle this off by going to Settings and making sure that this is not. This does not show up. And the tax here is exactly what we're talking about is exempt and you'll notice on purchases. QuickBooks Online doesn't actually give you an option between sales and purchases. This is simply going to be a purchase tax code and this dictates how it appears on your sales tax report. So the way a sales tax report is structured, you have your total sales, then you have your tax on sales and then you have your tax on purchases. So you want to make sure that the correct type of transaction I.e. sales or purchases is selected. So let's select exempt. We can say yes, Ashley, in this case because all bank charges will almost always be exempt and we will add this transaction.

That pretty much.

Reflects how you would add each type of transaction and how you would select it. I do have a blog post about this. It is very similar to what we have discussed, but you can read it just for a better understanding of what the differences are and some examples of transaction types. And also if you are interested in further reading on this fascinating topic, you can go to CRA's website. Just simply select exempt or zero rated in Google and it will take you to the website. So I hope this was useful and I hope this at least somewhat answers this very popular question as to which tax code to choose.

And one final piece of advice, if you are unsure, I recommend just simply selecting Exempt. And the difference is not necessarily significant.

It's.

The potential issue that you might have is with a Revenue Canada auditor who might be like, well why did you use exempt and not zero rated? But the chances of that are pretty low. So you can choose Exempt if you're unsure. But given the guidance and if you've watched this whole video, obviously accuracy is better wherever possible.

So that's it. Please like subscribe and let me know if there are any other questions that you have about QuickBooks Online and I will try and make a video about it.

And for a lot more information related to small business you can visit my website at montrealfinancial CA and you can learn a little bit more about this me as well my consulting services and I have several books for small businesses. Have a great day.