What sales tax is and how businesses treat it
A sales tax is a tax added to the price of goods or services. The business is only a collector. So the tax never goes into Sales; it goes into a liability account called Sales Tax Payable (or GST/HST Payable, Output Tax).
Two kinds are common around the world:
- Single-stage retail sales tax: charged only on the sale to the final consumer. Businesses buying goods to resell usually show an exemption number and pay no tax on them. Many provinces and US states use this (often called PST or state sales tax).
- Value-added tax (VAT, GST, HST): charged at every stage, but each business claims back the tax it paid on business purchases as an input tax credit (ITC). In effect only the value it adds is taxed. India, Canada, the UK, Australia and the EU use this type.
Rules to remember: show the tax on every invoice, keep invoices as proof, record tax at the time of the sale or purchase, and remit by the due date.
Recording sales and purchases with sales tax
Sale with a retail sales tax (8%)
Sale of goods 500 on account: Accounts Receivable 540 Dr. / Sales 500 Cr. / Sales Tax Payable 40 Cr.
Purchase of supplies for own use
A business pays retail sales tax on items it uses itself (not for resale). The tax is part of the cost: Supplies 108 Dr. / Cash 108 Cr. (100 + 8% tax).
Sales return
If a customer returns goods, reverse the tax too: Sales Returns 50 Dr. / Sales Tax Payable 4 Dr. / Accounts Receivable 54 Cr.
Commission
Some governments let the collector keep a small commission for collecting the tax. Record it as income: Sales Tax Payable Dr. / Cash Cr. / Commission Earned Cr.
GST, VAT and HST: input tax credits and remittance
With a value-added tax, keep two accounts:
- GST/HST Payable (credit balance): tax collected on sales.
- GST/HST Recoverable or Input Tax Credit (debit balance): tax paid on business purchases.
Sale 1,000 + 5% GST: Cash 1,050 Dr. / Sales 1,000 Cr. / GST Payable 50 Cr.
Purchase of equipment 600 + 5% GST: Equipment 600 Dr. / GST Recoverable 30 Dr. / Cash 630 Cr.
Net tax = tax collected − input tax credits = 50 − 30 = 20. If credits are bigger than tax collected, the government sends a refund.
In a combined system (for example a harmonized tax) the federal and provincial parts are charged as one rate on one line.
Sales tax for a service business and filing the return
A service business (salon, repair shop, consultant) charges tax on its fees, exactly like a shop on goods: Cash 1,130 Dr. / Fees Earned 1,000 Cr. / HST Payable 130 Cr.
At the end of each period (month, quarter or year) it fills a remittance form / tax return:
- Line A: total sales or fees (before tax).
- Line B: tax collected.
- Line C: input tax credits.
- Line D: net tax = B − C (pay if positive, refund if negative).
Closing entry when paying: GST Payable 50 Dr. / GST Recoverable 30 Cr. / Cash 20 Cr. After this, both tax accounts show zero.
Key formulas and definitions
- Tax = Price × rate ÷ 100
- Amount charged = Price + Tax = Price × (1 + rate/100)
- Price before tax = Total ÷ (1 + rate/100)
- Net tax to remit = Tax collected − Input tax credits
- Sales Tax Payable = liability; Input tax credit (Recoverable) = asset
Worked examples
1. A shop sells goods for 800 cash with 6% retail sales tax. Record the sale.
Tax = 800 × 6% = 48. Cash 848 Dr. / Sales 800 Cr. / Sales Tax Payable 48 Cr.
2. A business buys office supplies for its own use, 250 + 8% sales tax, cash. Record it.
Tax = 20, which is part of the cost (no credit for a retail sales tax). Supplies 270 Dr. / Cash 270 Cr.
3. A receipt shows a total of 1,180 including 18% GST. Find the price and the tax.
Price = 1,180 ÷ 1.18 = 1,000. Tax = 1,180 − 1,000 = 180.
4. In a month GST collected is 3,600 and GST paid on purchases is 2,250. How much is remitted? Write the payment entry.
Net = 3,600 − 2,250 = 1,350. GST Payable 3,600 Dr. / GST Recoverable 2,250 Cr. / Cash 1,350 Cr.
5. A plumber charges 2,000 for a job plus 13% HST on account. Record it.
HST = 260. Accounts Receivable 2,260 Dr. / Service Revenue 2,000 Cr. / HST Payable 260 Cr.
6. A new firm collects 400 GST but pays 950 GST on equipment. What happens?
Net = 400 − 950 = −550. The firm claims a refund of 550: Cash (or GST Refund Receivable) 550 Dr. + GST Payable 400 Dr. / GST Recoverable 950 Cr.
Common mistakes
- Crediting the whole amount to Sales. The tax part must go to Sales Tax Payable, a liability.
- Claiming an input tax credit for a single-stage retail sales tax. That tax is part of the cost of the item.
- Forgetting to reverse the tax on a sales return or discount.
- Working out the tax from a tax-included total by multiplying by the rate. Divide by (1 + rate) first.