Zero-Rated vs Exempt Supplies

Introduction
Understanding zero-rated vs exempt supplies is essential for any business registered for GST/HST or QST in Canada. Many business owners mistakenly believe that both categories mean “no tax,” but the tax implications are dramatically different. Zero-rated supplies are taxable at 0%, meaning businesses can still claim input tax credits (ITCs). Exempt supplies, however, are not taxable and do not allow ITCs. Misclassifying sales can lead to CRA or Revenu Québec reassessments, denied ITCs, penalties and interest. This guide explains the differences between zero-rated vs exempt supplies, the legal rules that apply, and how businesses can classify their products and services correctly.

Legal and Regulatory Framework
Zero-rated vs exempt supplies are governed by the Excise Tax Act and Québec’s Taxation Act.
These two categories are fundamentally different:

Zero-Rated Supplies (Taxable at 0%)

These are taxable supplies where the GST/HST rate is 0%. Businesses must:

• charge 0% GST/HST
• remain registered
• claim full ITCs on related expenses
• file GST/HST returns normally

Common zero-rated supplies include:

• basic groceries (milk, vegetables, rice, flour)
• prescription drugs
• feminine hygiene products
• exported goods
• medical devices (e.g., pacemakers, insulin pumps)
• certain farm products
• some international passenger transportation

Exempt Supplies (Not Subject to GST/HST)

These supplies are not taxable. Businesses must:

• charge no GST/HST
• usually not claim ITCs
• may not need to register for GST/HST if providing only exempt supplies

Examples include:

• residential rent
• childcare services
• health and dental services by licensed professionals
• financial services (banking, loans, insurance)
• music lessons for children
• certain educational services

Understanding zero-rated vs exempt supplies correctly helps businesses determine registration requirements and ITC eligibility.

Key Court Decisions
Canadian courts have issued significant rulings on zero-rated vs exempt supplies. Key principles include:

• classification depends on legislation, not business intent
• courts reject attempts to classify exempt supplies as zero-rated to recover ITCs
• bundled supplies must be analyzed carefully—one exempt component may change the taxability of the whole supply
• health services must meet strict professional licensing rules to be exempt
• food products must meet CRA’s “basic grocery” definition to qualify as zero-rated
• financial services are narrowly defined; administrative fees often remain taxable

Québec courts apply an equally strict approach when determining QST zero-rated and exempt classification, especially in health services, education and rental real estate.

These rulings show why businesses must understand zero-rated vs exempt supplies clearly to remain compliant.

Why CRA and Revenu Québec Target This Issue
The CRA and Revenu Québec frequently review zero-rated vs exempt supplies because:

• businesses often claim ITCs incorrectly on exempt activities
• service providers confuse zero-rated exports with exempt domestic services
• real estate transactions are misclassified
• health and wellness providers improperly claim exempt status
• e-commerce sellers misunderstand zero-rating for international clients
• food sellers misclassify prepared foods as zero-rated groceries

Audit triggers include:

• large ITC claims from exempt businesses
• incorrect tax charged on invoices
• revenue inconsistencies between GST/HST returns and income tax filings
• frequent refunds due to zero-rated sales
• sudden reclassification of taxable supplies as exempt

Understanding zero-rated vs exempt supplies protects businesses from costly reassessments.

Mackisen Strategy
Mackisen CPA provides a full, structured approach to classifying zero-rated vs exempt supplies:

• reviewing all products and services to determine tax status
• explaining whether GST/HST and QST apply to each type of supply
• ensuring proper invoicing and tax calculations
• advising whether a business must register for GST/HST or QST
• adjusting ITC claims based on classification
• correcting past filings through voluntary disclosure
• preparing GST/HST and QST returns with accurate classifications
• supporting clients in CRA and Revenu Québec audits involving supply classification
• coordinating place-of-supply rules for cross-border transactions

Our systematic approach ensures every supply is correctly categorized under zero-rated vs exempt supplies.

Real Client Experience
Many clients seek Mackisen after classification errors:

• A health coach incorrectly classified their services as exempt. CRA reassessed and demanded GST backpayments. Mackisen corrected filings and clarified exemption rules.
• A Québec bakery charged GST on zero-rated bread and lost customers. We corrected invoicing and ensured proper ITC claims.
• An e-commerce seller treated foreign sales as exempt rather than zero-rated, losing ITCs. Mackisen corrected exports classification and filed adjustments.
• A rental property owner incorrectly claimed ITCs on exempt residential rent. We reversed the claims and avoided penalties.
• A childcare center claimed ITCs despite providing exempt supplies. CRA denied all claims and charged interest. We restructured reporting to avoid future issues.

These examples show why businesses must understand zero-rated vs exempt supplies.

Common Questions
Business owners frequently ask:

• Are zero-rated and exempt the same?
No—zero-rated allows ITCs; exempt does not.

• Do exports count as exempt?
No—they are zero-rated.

• Are health services always exempt?
Only if provided by licensed professionals (e.g., doctor, dentist, psychologist).

• Do landlords charge GST/HST on rent?
Residential rent is exempt; commercial rent is taxable.

• Do I need a GST number if I only provide exempt services?
No—but you also cannot claim ITCs.

• Are groceries always zero-rated?
Basic groceries yes; prepared foods are taxable.

These answers clarify zero-rated vs exempt supplies.

Why Mackisen
With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps businesses stay compliant while recovering the taxes they’re entitled to. Whether you're filing your first GST/QST return or optimizing multi-year refunds, our expert team ensures precision, transparency and protection from audit risk. When advising on zero-rated vs exempt supplies, Mackisen provides complete classification, invoicing verification, sales tax compliance and CRA or Revenu Québec audit defense.