In the past month or so I’ve been doing a lot of digging into taxes and business ownership. Since I’m moving to full time freelance soon and it will be my only source of income, I’m doing all I can to find out what I need to know about working for myself. My first step was to find out whether I should be charging tax to my clients. Every day the things we buy have tax on them, and it seems like just a normal part of every day life. But, do you have to charge tax if you start selling goods or services to people? Well, here’s what I’ve discovered, in layman’s terms, because there is a lot of mumbo jumbo out there.
**I should add that since I live in Canada, this information only applies to Canadians or Canadian businesses. I can’t claim to know anything about businesses outside of Canada, and though some of these things may apply to non-Canadians, you should still research in your own country to know for sure!**
Income Tax vs. Sales Tax
This is one thing that confuses a lot of people. Income tax and sales tax are two completely different things. Every year, you must pay tax on your income to the federal government. These are the taxes you do every April and submit to the government. How much you owe or receive depends on your income, your expenses, your debt, etc.
Sales tax on the other hand is a tax that customers have to pay when they buy goods and services. If you run a business, you collect the tax from your customers and then pay that money to the government at the end of your business year. All businesses, except for some non profits, have to pay income tax, but not all businesses must pay sales tax.
What is Sales Tax?
First of all, let’s explore some of the basics. Taxes are charged on all goods and services in Canada, except for those that are exempt (such as necessities like bread, milk and vegetables). Tax in Canada is divided into three categories: PST (Provincial Sales Tax), GST (Goods and Services Tax) and HST (Harmonized Sales Tax). All three generally apply to the same goods sold or services provided in Canada. Every province has a GST of 5% and PST that varies. Some provinces (Ontario, and the Atlantic provinces) have combined the two to create a HST number that includes the total tax percent. You can check here to see the different tax rates per province, but in Ontario our PST is 8% plus GST of 5% for a totally HST of 13%.
Should I Charge Sales Tax?
In Canada, you have to charge sales tax for your goods or services if you are making more than $30,000 a year. If you are making less than $30,000 a year, you are considered a ‘small supplier’ and are exempt from charging tax to clients or customers. You can still choose to charge tax if you want to, but you are not legally required to.
If you do not charge tax because you’re expected income is less than $30K, but then you end up making more than that, don’t fret. You don’t need to go back and worry about all the invoices or sales you made, you just need to start charging tax once you have passed the $30K mark. It’s a little tricky because technically the rule is 13 months rather than 12. So if you pass $30K in the month after a full business year, you must start charging tax. You have to charge tax on the sale that took you over the $30K mark, and all sales after that. You then have 29 days to register for an HST number.
How do I Charge Tax?
In Canada, you must register and receive an HST number to be able to legally charge tax. You can register easily online and you immediately receive your HST number. From then on you must start charging tax to your customers. The government uses the HST number they have assigned to you to track how much tax you charge, how much you collect, and how much you owe them at the end of the year. Though the HST makes it seem like you are making more money, that money is not really yours, since you have to pay it to the government at the end of the year. Make sure you keep track of how much HST you have collected so that you are never surprised by the amount you owe.
It is illegal, and technically fraud, to charge HST when you have not registered and do not have an HST number. This is because you are collecting tax from clients under the premise that you will be paying it to the government, but since you haven’t registered the government doesn’t know to track or expect the money from you. So, you are committing fraud. I learned this from my small business advisor a little while ago, after (at a client’s request) I had charged tax without giving it a second thought. Since I hadn’t registered for an HST number this was fraud, and to remedy the situation I had to re-issue their invoices and refund them the tax.
Once you have charged and collected HST you must then fill out an GST/HST tax return at the end of your fiscal year. If your fiscal year ends December 31st, then you can file your Sales Tax at the same time as you file your income tax, with payments being due by April 30th. You can do this online, in person, or by mail depending on your preference and what kind of business you have and how much you owe.
Things also get a little more complicated when you are dealing with customers who do not live in the same area that you do. In my business, since it is virtual and I perform most of my services online without ever meeting my clients in person, it is more common to do business with people from out of province. If I am working with someone from out of province, I have to charge them tax based on what their province’s tax rates are, not my own. If I sell to customers out of Canada, I do not have to charge tax at all.
Do I Want to Charge Tax?
If you are making less than $30,000 a year, it is your choice whether you want to charge tax or not. If you choose to, you must register for an HST number as above. If you decide not to charge tax, you just go on as you usually would, not charging tax on goods or services.
So how do you decide? It’s really a matter of preference. My business advisor told me to just keep it simple, and I agree. Charging tax when you aren’t required to just means more complication. Not charging HST just means that you have less paperwork to file, less work to do in finding out how much tax to charge based on location, and less headache. But, there are a few minor advantages to charging HST. First of all is the fact that if you do exceed the $30K threshold, you will already be prepared and charging HST, and there will be no last minute scramble to start charging. Secondly, there are some tax rebates you can claim on HST that you have charged, and you may not have to give all the HST you have collected to the government, meaning you make a little more money.
Knowing whether to charge tax and making sure you’re following all the legal steps to running a business can be stressful if you let it get the best of you. Just make sure you are aware of the rules, and keep things as simple and organized as possible. If you need to, or want some extra advice, most areas in Canada have free small business advisors that will meet with you and help you sort out all the questions you have associated with your business. It only took one meeting with my business advisor for me to finally figure things out, and it was like a breath of fresh air finally knowing that I was doing things right.