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Running a business

Value-Added Tax: What is VAT and how does it work?

If you're a new business owner looking into the tax implications of starting your first business, you've probably asked yourself, "What is VAT?"

Value-added tax (VAT) is a consumption tax added to the cost of goods and services that businesses sell. The federal government charges a VAT — known as the goods and services tax (GST) — while provinces may charge their own VATs.

In some provinces, the federal and provincial VATs are combined into a single tax known as a harmonized sales tax. A VAT is one type of consumption tax — a tax that consumers pay directly or indirectly when they purchase goods and services. With VAT, consumers pay based on the amount they spend when they buy taxable goods or services. While managing taxes, collecting taxes, and filing taxes are not most business owners' favourite items on their to-do list, a little knowledge can make VATs easier to manage.

What VAT means and how it works

VAT means value-added tax, and a VAT is collected on goods at every stage as they move through the supply chain. For example, VAT may be collected on the cotton used to make cloth, the cloth purchased by a clothing manufacturer, and the dress made from that cloth and purchased at a boutique by the end consumer.

Most businesses must collect the federal VAT — known as the GST — and remit it to the Canada Revenue Agency (CRA). Small businesses that meet the definition of a"small supplier" do not need to register and remit the federal VAT, which is 5% on the sale of most goods and services. A small supplier is a business owner with revenue less than $30,000 in the past year. Once your business surpasses the $30,000 threshold, you must register and remit the federal VAT.

Examples of goods and services that are subject to VAT in Canada include cars, clothing, electronics, furniture, and professional services.

Some goods and services are exempt from the federal VAT. Examples include:

  • Basic groceries, such as bread, milk, and vegetables
  • Prescription drugs and medical devices, such as hearing aids
  • Agricultural products, such as grains and raw wool
  • Travel services with an origin or destination outside the country
  • Music lessons
  • Legal aid services

In some provinces, the GST has been combined with a provincial sales tax (PST), which is another type of VAT. In these provinces, the combined tax is known as the harmonized sales tax (HST). These provinces are Labrador, New Brunswick, Newfoundland, Nova Scotia, Ontario, and Prince Edward Island.

In other provinces, businesses must collect the GST and a PST. All of these federal and provincial taxes are VATs because they are charged to consumers and added to the sale price of most goods and services sold in Canada.

Tracking your sales and the amount of VAT collected is key to staying in compliance with federal and provincial tax laws — and good business bookkeeping is key to getting this right.

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What is VAT and how do I pay it?

The VAT tax you must collect varies based on the province where the goods or services are sold. VAT tax varies from 5 to 15%, depending on the province. Wondering what the VAT tax rate is where your business is located? Here's a chart of VAT tax rates by province.

Businesses technically don't pay VAT. Instead, most businesses must collect the VAT from customers or clients and remit this tax to the government. You can pay VAT either electronically, at your bank, or by mail. Payments of $50,000 or more must be made using one of the first two methods. If you want to make sure you're collecting and remitting VAT properly, consider getting help from a small business accountant.

What is a VAT number?

The CRA issues a federal business number (BN) to every business that has accounts with the federal government. The BN is used for all types of tax accounts, including the Canadian federal VAT, known as the GST. In addition to being used for the VAT, this number is also used for corporate income taxes, payroll taxes, and other types of federal taxes.

To create the VAT number, the CRA will add a program identifier (2 letters) and a reference number (4 digits) to the 9-digit BN. If a business runs two separate businesses under one BN, they can apply for a separate reference number to have a separate VAT number for each business.

Now that you know what VAT is and how it works, make sure your business is charging and remitting VAT properly. Let QuickBooks help make it a snap to collect and pay taxes, and manage all other aspects of your business.

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