Zero-Rated vs Exempt Supplies – A Complete Guide by a Montreal CPA Firm Near You

Introduction

Understanding the difference between zero-rated and exempt supplies is essential for every Canadian business that charges (or should charge) GST/HST. These two categories determine whether you must charge tax, whether you may claim input tax credits (ITCs), and how you complete your GST/HST return. Many businesses mistakenly treat exempt supplies as zero-rated, leading to denied ITCs, CRA reassessments, and costly penalties. Others fail to realize they are providing zero-rated services and miss out on claiming full ITCs. Because the sales tax consequences are significant, every freelancer, healthcare provider, consultant, educator, and online seller must understand the critical distinction between zero-rated and exempt supplies in Canada.

Legal and Regulatory Framework

GST/HST classification is governed by the Excise Tax Act, specifically:

• Schedule VI – Zero-Rated Supplies
• Schedule V – Exempt Supplies
• Section 165 – GST/HST tax application rules
• Section 169 – Input tax credit eligibility

Zero-Rated Supplies (Taxed at 0%)

Zero-rated items are taxable supplies charged at a rate of 0%. Examples include:
• basic groceries
• prescription drugs
• exported goods and services
• certain medical devices
• feminine hygiene products
• international transportation
• certain agricultural products

Businesses selling zero-rated supplies:
• do not charge GST/HST, but
• can fully claim ITCs on related expenses.

Exempt Supplies (Not Taxable)

Exempt supplies are non-taxable. Examples include:
• residential rent
• most healthcare services
• educational services (certain categories)
• financial services
• child care
• long-term care

Businesses selling exempt supplies:
• do not charge GST/HST, and
• cannot claim ITCs on expenses related to those activities.

This distinction forms the core legal difference between zero-rated and exempt supplies.

Key Court Decisions

Numerous cases highlight the complexity of classification.

In Cornwallis Financial Corp. v. Canada, CRA denied ITCs because the business offered exempt financial services, confirming that ITCs cannot be claimed for exempt activities.

In River Cree Resort Limited Partnership v. Canada, the court analyzed mixed-use supplies and emphasized that classification depends on the predominant element of the service.

In Tele-Mobile Co. v. The Queen, CRA successfully reassessed sales tax on misclassified telecommunications services, underscoring that errors in classification lead to tax liability.

In Northwest Hydraulic Consultants Ltd. v. Canada, although not directly about classification, the court reinforced that taxpayers must demonstrate clear connections between expenses and taxable activities to claim ITCs.

These cases reveal how classification disputes often end up in court—and CRA typically prevails.

Why CRA Targets This Issue

CRA frequently audits zero-rated and exempt supplies because:

• businesses incorrectly claim ITCs on exempt activities
• many confuse zero-rated and exempt classifications
• mixed supplies (e.g., training + consulting, medical + cosmetic services) require detailed allocation
• e-commerce sellers misunderstand export rules
• landlords attempt to claim ITCs on residential rentals (not allowed)
• health and wellness practitioners misapply exemptions
• financial advisors incorrectly treat taxable advisory services as exempt financial services

CRA also checks whether sales tax returns properly reflect the type of supply. Any mismatch triggers a review.

Mackisen Strategy

At Mackisen CPA Montreal, we help businesses classify their supplies correctly and maintain full GST/HST compliance. Our systematic approach includes:

• analyzing your services and products to determine whether they are taxable, zero-rated, or exempt
• preparing documentation to support classification decisions
• separating taxable and exempt activities for ITC allocation
• advising health, financial, educational, and childcare providers on exemption rules
• ensuring exported products or services qualify as zero-rated
• implementing bookkeeping systems to track ITC eligibility
• reviewing GST/HST return completeness and accuracy
• assisting with CRA audits involving classification disputes

This framework ensures businesses avoid reassessments and maximize allowable ITCs.

Real Client Experience

A health practitioner provided both medical and cosmetic treatments but treated all services as exempt. CRA reassessed her, determining cosmetic procedures were taxable. We restructured her invoicing and corrected three years of filings, preventing penalties.

A small grocery importer selling zero-rated foods and taxable snacks incorrectly treated everything as exempt. CRA intervened. We separated zero-rated and taxable goods, recalculated filings, and recovered ITCs.

A landlord attempted to claim ITCs for repairs on a residential rental property. CRA denied all credits. We educated them on exemption rules and helped restructure future filings.

Common Questions

Business owners often ask whether zero-rated means tax-free. It means taxable at 0%, with ITCs allowed.
Others ask whether exempt sales allow ITCs. No—exempt supplies do not permit ITCs.
Some ask whether exporting services always qualifies as zero-rated. Usually, but documentation is required.
Another question: Are educational courses exempt? Only specific certified programs; many online courses are taxable.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps Canadian businesses classify supplies correctly and avoid costly sales tax errors. Whether you provide services, sell goods, or run an online business, our team ensures accuracy, compliance, and ITC optimization.