Zero-rated supplies are goods and services that hold a very niche spot in the tax system. It’s especially important for remote sellers to understand the definition!
Read on to learn:
- The difference between zero-rated and tax-exempt
- How VAT and GST rules use the term
- Which products fall under this category in the EU, UK, and other countries around the world.
The definition of zero-rated
Zero-rated means exactly what it sounds like: a tax rate of 0%. These goods and services do not have any amount of VAT or GST added to the final retail sale.
(No, they are not exempt from tax. Yes, this is a confusing point of bureaucracy! We’ll cover the difference later on.)
The rate of 0% allows the usual chain of input tax credits to stay in place. So businesses and manufacturers can claim input tax on the purchase, thus deducting it from whatever VAT or GST they owe later.
Understanding how consumption taxes work will help you see how this zero-rated process functions throughout the supply chain.
What types of goods are zero-rated?
A zero-rated supply is typically a good or service that’s a key component of producing some other final product. Indeed, it’s part of the supply chain for that end product. Governments don’t want to overtax items that are essential to further manufacturing.
Similarly, most governments don’t want to overtax items that are considered the bare necessities of life, such as food, water, medicine, and sanitary products. Zero-rating these goods and services means that the final market price is more affordable for end consumers.
Finally, exports are often included, too. In these cases, most goods and services for which you charge and collect VAT or GST at home, are actually zero-rated when exported out of the country. This keeps domestic goods attractive to international buyers.
There are also effects for the producers of the goods, which we’ll explain in the next section!
What is the difference between zero-rated and tax exempt?
According to the Tax Policy Center, the difference comes down to how steps and materials in the supply chain are taxed, and whether businesses can make those deductions when they file their taxes.
For a “zero-rated good,” the government doesn’t tax its sale and allows credits for the tax paid on inputs. In other words, deductions are possible!
If a good or business is “exempt,” the government doesn’t tax the sale of the good, but producers cannot claim an input credit for the VAT or GST they paid to produce it.
Because producers can’t get that money back in a tax break, they might try to get it back in revenue — by raising the retail price of the product. So in these cases, what we call “tax-exempt” might actually just have VAT or GST hidden within the price, what the EU calls “residual VAT”.
Note: There is one more type of transaction that doesn’t have tax applied, those that use the reverse-charge mechanism. But with these sales, which are often B2B, it’s important to know that VAT or GST is eventually paid by the buyer!
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Zero-rated EU VAT
In the EU, the 27 countries mostly agree to the same laws but have some leeway to determine their own tax rates, including “special rates” that are below 5%.
For example, there are some things that EU countries must exempt, and some supplies that they may choose to exempt. According to the European Commission:
“Supplies that must be exempt include certain activities in the public interest (such as medical and dental care, social services, education etc.) as well as most financial and insurance services and certain supplies of land and buildings. Exemptions also exist for intra-EU supplies and exports of goods outside the EU.”
If Europe is your main market or your next conquest, check out our complete explanation of how to comply with EU VAT.
In GST laws, it’s sometimes referred to as “nil-rated supply.” But the concept is the same: there is no tax added to the final sale, and businesses can claim input credits on tax they paid along the way.
If you’re curious about GST rules in specific countries, check out the following guides for businesses:
- Canadian GST for businesses
- Australian GST for businesses
- New Zealand GST for businesses
- Indian GST for businesses
Common zero-rated goods and services
Here is a short ( and by no means comprehensive!) list of items that are commonly taxed at a rate of 0%.
- Basic groceries such as milk, bread, and vegetables
- Agricultural products such as grain, raw wool, or dried tobacco leaves
- Most farm livestock
- Most fishery products, particularly fish for human consumption
- Prescription drugs and drug-dispensing services
- Certain medical devices such as hearing aids
- Feminine hygiene products
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.