Understanding GST/HST as a Liability, Not an Expense
GST/HST is a common topic of inquiry among our clients, particularly those starting up a business. One recent question we encountered was, "How should I expense GST/HST on my business purchases?" There can be a lot to unpack from this simple question, but it often reveals a common misunderstanding among small business owners—a lack of awareness that is entirely understandable. That's exactly why we're here to help.
The aim of this post is to clarify this area for those with similar questions, helping to alleviate some of the confusion and set you on the right path. We will briefly cover some fundamental concepts and guide you through the correct setup of a general ledger account for GST/HST. Additionally, we'll address some special considerations related to GST/HST.
What is GST/HST?
GST (Goods and Services Tax) and HST (Harmonized Sales Tax) are value-added taxes levied on most goods and services sold in Canada. Businesses collect GST/HST from customers on taxable sales and are required to remit these amounts to the government. While it may seem like the GST/HST your business collects is revenue, it’s actually a liability that must be paid to the Canada Revenue Agency (CRA).
Common Misunderstanding: GST/HST as an Expense
Many business owners mistakenly treat the GST/HST they pay on their purchases as an expense. However, this tax is generally recoverable through Input Tax Credits (ITCs). ITCs allow businesses to claim back the GST/HST paid on eligible business expenses, effectively reducing the net tax they owe to the government.
Setting Up Your Accounting System
To properly account for GST/HST, it’s essential to set up the correct accounts in your accounting system. Here’s how to do it:
1. Create a GST/HST Liability Account
Account Type: Liability
Purpose: This account tracks the GST/HST you collect from customers and the GST/HST you pay on purchases.
Function: When you collect GST/HST on sales, the amount is credited to this account. When you pay GST/HST on expenses, the amount is debited from this account, reflecting the ITCs you are entitled to claim.
2. Create an Input Tax Credits (ITCs) Account
Account Type: Contra Liability (or Sub-account under the GST/HST Liability Account)
Purpose: This account tracks the GST/HST paid on eligible business expenses that you can claim as ITCs.
Function: The ITCs reduce the GST/HST liability, so when you enter expenses that include GST/HST, the amount of tax is recorded in the ITCs account.
Recording GST/HST on Expenses
When you incur an expense that includes GST/HST, you need to properly account for the tax portion to ensure your books are accurate. Here’s how to record a typical expense:
Example: Office Supplies Purchase
Total Cost (Including GST/HST): $113 (assuming a rate of 13%)
Base Cost of Office Supplies: $100
GST/HST Paid: $13
Accounting Entry:
Expense Account (Office Supplies): Debit $100
ITCs Account: Debit $13 (this reduces your GST/HST liability)
Bank or Accounts Payable Account: Credit $113 (the total amount paid)
This entry ensures that the expense is accurately recorded and that the GST/HST paid is accounted for in the ITCs account, reducing your overall liability.
Claiming and Remitting GST/HST
At the end of your reporting period (monthly, quarterly, or annually), you’ll need to file your GST/HST return and remit any tax owing to the CRA.
1. Calculate Net Tax Payable
GST/HST Collected: Sum of all GST/HST amounts collected on sales during the reporting period.
ITCs Claimed: Total GST/HST paid on eligible expenses during the same period.
Net Tax Payable = GST/HST Collected - ITCs Claimed
2. Remit or Claim a Refund
If Net Tax Payable is Positive: This amount is what you owe to the CRA and should be remitted by the due date.
If Net Tax Payable is Negative: You can claim a refund from the CRA.
Accounting Entry When Remitting GST/HST:
GST/HST Liability Account: Credit the amount of GST/HST being remitted to zero out the liability.
Bank Account: Debit the amount being paid.
Special Considerations
GST/HST Exemptions
Some businesses, particularly in the healthcare sector, may be exempt from charging GST/HST. For example, many physiotherapy services are exempt from GST/HST. However, even exempt businesses may still need to account for GST/HST on certain purchases and can still claim ITCs on those eligible expenses.
Specific Rules for Certain Expenses
Example: Meals and Entertainment. The CRA allows businesses to claim only 50% of the GST/HST paid on meals and entertainment expenses. This means if you spend $100 on a business lunch (with $13 HST), you can only claim $6.50 as an ITC.
Accounting Entry for Meals and Entertainment:
Meals and Entertainment Expense Account: Debit $106.50*
ITCs Account: Debit $6.50 (50% of the GST/HST paid)
Bank or Accounts Payable Account: Credit $113 (the total amount paid)
*There are specific rules around Meals and Entertainment. In the above example we are assuming that the entry is being recorded in the regular course of business and not for tax preparation purposes.
Conclusion
Properly accounting for GST/HST on expenses is essential for accurate financial reporting and compliance with CRA regulations. By understanding that GST/HST is a liability, not an expense, and by setting up your accounting system correctly, you can ensure that your books are accurate and that you’re taking full advantage of ITCs. Regularly reviewing your GST/HST accounts and staying up-to-date with CRA rules will help you avoid errors and potential penalties.
If you have any doubts or specific questions about how to handle GST/HST in your business, it’s always a good idea to consult with a professional bookkeeper or accountant. By staying informed and organized, you can manage your GST/HST obligations efficiently and focus on what matters most—growing your business.
