What is value added tax? Is there VAT in Canada?

Whether you like it or not, taxes are a part of everyday life in most parts of the world and Canada is no exception. In addition to income tax, property tax, and capital gains tax, Canadians often find that they end up paying a sales tax on most goods and services that they buy.

You’ll often see sales taxes listed on your receipts when you make a purchase online or in a store. But in many countries, “sales tax” isn’t usually marked on your receipt as “sales tax.” Rather, it might be called VAT, or a Value Added Tax.

But what is VAT and is it even a thing in Canada?

The short answer? Yes, kind of. Canada does have a VAT-like tax that’s called the Goods and Services Tax (GST) or, in some provinces, a Harmonized Sales Tax (HST). Both the GST and HST function in similar ways to VAT, but there are some slight differences.

In this article, we’ll take a closer look at VAT and how it works. We’ll also look at how Canada taxes goods and services within its borders and how this practice differences from other countries.

What is Value Added Tax (VAT)?

Value Added Tax, or VAT, is a type of sales or consumption tax that’s charged on a wide range of goods and services. Technically speaking, VAT is levied and collected on a product at every single stage of its production, from the purchase of its raw materials to the time it’s sold to you.

How it works is somewhat complicated. The idea is that every single company or individual involved with a product’s supply, distribution, and sales chain ends up paying a portion of its VAT. This is different from a true sales tax where the tax is only charged when a product or service is sold to consumers.

The best way to understand how VAT works is to see it in action. Let’s take a hypothetical scenario of a loaf of bread that’s sold at a bakery in a country with a 10% VAT rate. Here’s what would happen to that loaf of bread and the taxes that it collects as it goes from farm to fork:

1. A farmer sells a kilogram of raw grain to a flour company for $1. The flour company pays the cost of the raw materials ($1) plus the 10% tax ($0.10), which works out to a total cost of $1.10.

2. The flour company mills the grain and produces white flour that’s sold to a wholesale distribution company for $3 a kilogram. The wholesale distribution company pays the cost of the flour ($3) plus the 10% tax ($0.30). However, the company only actually pays $0.20 in tax because they aren’t liable for the VAT costs already paid by the flour company ($0.10).

3. The wholesale distribution company sells their flour to a local baker for $5 a kilogram. The baker pays the cost of the flour ($5) plus the 10% tax ($0.50). But, the baker only pays $0.20 in tax, because the other companies in the supply chain have already paid the rest.

4. The baker sells you an assortment of loaves of very nice artisanal, hand-crafted bread for $10 using all of the flour bought from the wholesale distribution company. You pay the cost of the bread ($10) plus the 10% tax ($1) using your sleek KOHO prepaid Mastercard. But you theoretically only pay $0.50 in tax, because the rest was technically already paid by everyone else in the supply chain.

If all of this sounds complicated, that’s because it is. We’ve of course skipped some steps in the process and have overlooked the fact that there are more ingredients in bread than just flour. But the take-home point from this example is that VAT is supposed to be charged to every single organization involved in a supply chain to raise government revenue.

Theoretically, the social cost of this tax should be distributed among all the companies that work to produce the items and services we use every day. The reality is that this cost usually gets passed down to consumers and it normally involves some tricky bookkeeping for many businesses.

The politics as well as the pros and cons of VAT are beyond the scope of this article, but hopefully, our example of flour, bread, and VAT gave you a better idea of how this system works.

Does Canada have Value Added Tax?

Now that you’re a certified expert in all things VAT, you might be asking yourself: Does Canada have a Value Added Tax?

Long story short: yes, Canada technically has a Value Added tTax. It’s just not called VAT. Rather, Canada has a VAT-like system called GST and HST. Quebec also has its own VAT system called QST and some provinces have a separate tax called PST. Here’s what you need to know.

What is the Goods and Services Tax (GST)?

Canada’s federal version of the VAT is officially called the Goods and Services Tax (GST). As of the time of writing, the GST is 5% and this is a tax that’s levied on most goods and services made in Canada. It also technically applies to certain types of property transactions and to downloadable digitized goods.

There are a few instances where people and organizations, by law, do not need to pay GST, but these are limited. For example, under section 87 of the Indian Act, most Indigenous peoples in Canada are not liable for GST when purchasing property or services on a reserve.

However, note that while GST is technically charged on most goods and services, some things are called “zero-rated.” This means that their GST rate is 0%, so you effectively don’t pay GST. These items include basic groceries, prescription drugs, farm equipment, menstrual hygiene products, medical devices, and other necessities.

What is the Harmonized Sales Tax (HST)?

In addition to the GST, many provinces charge their own VAT-style taxes. In fact, with the exception of people who live in Nunavut, Northwest Territories, Yukon, and Alberta, all Canadians pay provincial sales taxes of some sort. What this tax is called and how it’s levied can vary.

To start, we have the Provincial Sales Tax (PST), which is currently charged in British Columbia, Manitoba, and Saskatchewan at varying rates of 6 to 7%. Quebec also has its own sales tax called the Quebec Sales Tax (QST) that currently has a rate of 9.975%.

The specifics of how the PST and QST are charged are fairly similar, so we won’t get into the weeds here. But the basic idea is that these taxes are charged in addition to the GST. So in Quebec, for example, you’ll pay the base 5% GST plus the QST of 9.975% on taxable goods and services.

To complicate things even further, Canada has something called the Harmonized Sales Tax (HST). The HST is charged in New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, and Prince Edward Island. Rates for the HST vary from province to province but are about 13 to 15%.

The confusing part about this is that the HST actually includes the GST. So the 15% HST you pay in Nova Scotia already includes the 5% GST you pay to the federal government. The other 10% you pay is given to the provincial government.

The only real practical difference between HST and PST is that HST allows both the provincial and federal taxes to be combined (they’re “harmonized”) into one line item. Meanwhile, PST/QST and GST are charged separately. For consumers, this doesn’t make a huge difference, but it affects bookkeeping for Canadian businesses.

How does Value Added Tax work in other countries?

All this tax talk is enough to make anyone’s head spin. But it’s worth noting that Canada isn’t the only country that has a fairly complex consumer tax system.

Many countries actually have a VAT tax that’s very similar to Canada’s. To be fair, Canada’s is a bit more complex because there are variations between provinces and territories. But on a federal level, GST and other VAT systems are very similar.

For example, the United Kingdom uses VAT for most goods and services. The standard VAT rate is 20%, the reduced rate for certain goods is 5%, and some items are charged a zero rate, just like in Canada.

Most countries in Europe have a similar VAT rate, such as France (20%) and Spain (21%). Andorra is a notable European exception with a rock-bottom VAT of just 4.5% that lowers to 1% for certain goods and services.

Despite the popularity of VAT around the world, there is one major country that doesn’t use it: the United States. There isn’t actually a federal sales tax in the US, though all but five states have their own sales tax (Oregon, New Hampshire, Montana, Delaware, and Alaska are the exceptions).

Even so, these state and local sales taxes in the US are not the same as VAT or GST in Canada. Instead of being charged to every organization in the supply chain like VAT, sales tax in the US is just charged to consumers of a good or service.

That means you’ll pay the 4% state sales tax in New York for a pair of shoes at the point of sale, but the manufacturer, retailer, and other people involved in the supply chain don’t pay anything. This is one of the reasons why taxes in the US show up when you go to check out at the register, but not on an item’s price tag.

Taxes, taxes, taxes

Regardless of what you call it, Canada does technically have a Value Added Tax. The Canadian GST is a federal tax charged on most purchases in the country while some provinces have their own additional VAT-style taxes. Now you can go forth into the world and be more knowledgeable about the taxes you pay every day on goods and services.