What is the Difference Between Zero Rated, Out of Scope and Exempt and how do you choose in QBO?

In QuickBooks Online (QBO), the terms "Zero Rated," "Out of Scope," and "Exempt" refer to different classifications of transactions for GST/HST and QST (in Quebec).  Each one of these transactions results in $0 tax being added to the transaction, and if you use them interchangeably it is probably not a huge problem.  That being said, there are a couple of reasons you might want to ensure that you get this right:

• ensure accuracy in their books

• avoid the small possibility that an a government (Revenue Canada) auditor might nitpick at it or

• make your sales reports more accurate

The differences between the three classifications, which despite their somewhat technical names, are actually not that complicated. 

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Zero Rated:

Transactions classified as "Zero Rated" are taxable but at a 0% tax rate. This means that while no sales tax i.e. GST/HST or QST is charged to the customer, the seller can still claim input tax credits for any sales tax paid on related purchases or expenses.  This is particularly applicable to business who provide goods or services to customers in the US or internationally that if provided in Canada would require you to charge GST/HST and or QST.

Examples include sales of products such as clothing (or anything else on which you would charge GST/HST) to your Canadian customers . Also included are services such as marketing, IT or accounting.

Out of Scope:

Transactions that are "Out of Scope" are those that to which sales taxes are, in a sense, simply not applicable. And since sales tax is not applicable you also cannot claim input tax credits for these transactions.

Examples include payments from your bank account to your credit card account, withdrawals from the business, personal transactions paid for by the business.  Transfers between accounts.

Exempt:

"Exempt" transactions are those that are exempt from sales tax. This means that no GST/HST or QST is charged on sales.   The difference between exempt and zero-rated transactions is that sales tax would never be charged on these types of transactions as they are essentially exempt at source.  Also, unlike zero rated transactions, if you provide exempt goods or services, you cannot claim back sales tax (GST/HST) paid on expenses.  If you have a mix of exempt and taxable sales, you could claim the sales tax on purchases that relate to your taxable sales.  For expenses that apply to your business as a whole, such as accounting or legal fees, you would take a percentage based on the allocation between exempt and taxable sales.

Examples include Educational and health services are largely exempt (although there are some exceptions).  Also, financial services including bank charges and interest are exempt.

How to Record Zero Rated, Out of Scope and Exempt Transactions in QBO:

In QBO, after you set up your GST/HST reporting there will be a dropdown of tax codes where you would select the one that is most applicable to the type of transaction. My video below explains each type of tax code and shows you an example of each:

If you are not sure which tax code to use and you know that GST/HST (and/or QST) is not charged, I usually recommend selecting exempt.

Ronika Khanna is an accounting and finance professional who helps small businesses achieve their financial goals. She is the author of several books for small businesses and also provides financial consulting services. Subscribe to her biweekly newsletter to receive articles on financial literacy, tips, tools and special offers for small businesses.