With the return to the old regime in British Columbia, businesses are now forced to comply with the complexity of 2 separate consumption taxes (i.e. PST and GST). What prompted this discussion were the challenges faced by one of our clients – a software developer – in complying with the new regime.
To begin with small businesses must understand that accounting software isn’t expert software. Too often there is an expectation that commercial accounting software will provide professional expertise and guide inexperienced users into automatically recording transactions – including sales taxes – correctly.
In fact, from a marketing perspective Canadian customers are not a terribly important source of revenue to an international firm like Xero Limited. Xero is more focused on Australia, New Zealand (local markets), the UK, India and the US (large markets). As a result the software provides adequate generic tools to support various tax jurisdictions, but little or no ‘localization’ for secondary markets like Canada.
No matter how well accounting software has been localized to handle the mechanics of sales tax calculations for a particular jurisdiction, it simply isn’t realistic to expect the software to provide any expertise with respect to understanding what transactions are taxable or at what rates taxes need to be calculated. In fact such determinations are difficult for tax professionals, who invariably need a great deal of context before making decisions.
Handling GST in Xero
The Goods and Services Tax in Canada is a ‘value-added’ tax (aka “VAT”). That means businesses only pay tax on the value they add in taking products and services to the ultimate consumer. It is the ultimate consumer – at the end of the process – who pays the full amount of tax on the good. In the simple case of a consumer good – like a pair of shoes. The end user buys the shoes and pays GST on the full cost of the shoes.
The manufacturer buys raw materials and pays tax on the materials. It then ‘adds value’ by putting the raw materials through a manufacturing process and sells the shoes – usually to a retailer. The manufacturer charges GST on the sale price to the retailer. The difference between the GST collected on the sale price and the GST paid on the cost of the raw materials is remitted to the Canada Revenue Agency (the “CRA”).
Similarly the retailer collects GST from the consumer and gets a rebate from the CRA of the GST paid to the manufacturer. In the end, the final consumer pays the full amount of GST.
This type of value-added tax is commonplace in many countries (other than the US). Xero is familiar with handling value-added taxes and does a good job of handling Canada’s GST. All of the GST collected on sales and paid on purchases is collected in the Sales Tax Payable account.
Handling PST in Xero
Companies that charge PST to customers must remit the PST collected to the their provincial tax authority. However they don’t get any credit for PST paid on purchases. Instead PST paid is treated simply as a part of the cost of the good or service that was purchased.
This approach to sales taxes results in business paying tax on certain of their inputs. Typically raw materials and goods for resale are exempted from PST. However companies must still pay PST on overheads like telephone bills, tools and utilities. The PST paid is generally expected to form a part of the cost of any taxable good or service. Instead of being claimed as reduction or offset of PST collected, the PST ends up on the income statement as an expense.
Unfortunately Xero doesn’t handle this very elegantly.
This means that when entering PST on expenses, it should actually be entered as a second expense line (i.e. currently 7% of the taxable purchase) and should be allocated to the same account as the purchased item:
Supplies expense $100
Supplies expense …..7
Sales tax payable ……5
So we have 2 supplies expense lines. The first is subject to GST (input tax credits) at the current rate. The 2nd line represents the PST paid on the supply.
In this way the GST reports correctly as an input tax credit. The PST reports as an expense. Unfortunately the balance in the Sales Tax Payable account combines both GST and PST. So PST should NOT be set up as a sales tax.
Ideally there would be 2 separate Sales Tax Payable accounts (i.e. GST and PST), however it can be made to work as shown above. Of course other workarounds are possible – but they are workarounds, and could easily be misunderstood by bookkeeping staff.