Are digital products taxable in Canada?

The Goods and Services Tax (GST) and Harmonized Sales Tax (HST) are consumption taxes levied in Canada on the supply of most goods and services. The rules for nonresident businesses selling digital products in Canada depend on whether sales are made to other businesses (B2B) or directly to consumers (B2C).

The standard GST/HST rate is 5%, though some provinces have harmonized their provincial sales taxes with the GST to create an HST rate between 11-15%. Businesses with over CAD 30,000 in B2C sales must register and collect GST/HST at the federal level. For B2B sales, the reverse charge mechanism applies, where the Canadian business self-assesses the tax rather than the nonresident supplier.

Some Canadian provinces have their own tax regimes that require registration and tax collection separately from the federal level. Rules for B2B and B2C transactions can also vary at the provincial level. Businesses selling into Canada should be aware of both the federal and provincial tax regulations where their customers are located.

Determining if your product is taxable in Canada

To determine whether GST/HST applies to the sale of your digital product or service, there are three main factors to consider:

1. Customer's location: You need to identify the location of your customer, as tax regulations vary by country. Common pieces of evidence for customer location determination include billing address, customer account address, and credit card country.
2. Taxability of your product: Your digital product or service needs to qualify as a digital good or service for GST/HST purposes. This typically means that it is delivered electronically over the Internet or an electronic network, is automated, relies on technology, and is not a physical good.
3. Customer’s tax registration status: If you sell to other businesses located in Canada, you should collect and validate their tax registration numbers (tax IDs). In Canada, sellers are not responsible for GST/HST on B2B transactions with the proper documentation, and the responsibility of accounting for tax is transferred to the buyer through a reverse charge mechanism.

Getting GST/HST compliant in Canada

To ensure compliance with GST/HST regulations, here are the general steps that a nonresident company selling software or other digital products should take:

1. Collect customer addresses and tax IDs: Even if you are not registered for GST/HST, collecting customer tax IDs can save you expenses in the future. This step can be taken right away for customers outside the US.
2. Understand your GST/HST obligations: Determine where you have GST/HST obligations by cross-checking customer locations and the product taxability and registration thresholds in each country. Each country has its own registration threshold, which triggers the requirement to register.
3. Monitor GST/HST exposure and register in exposed jurisdictions: If your sales reach the registration threshold in Canada, you are required to register for tax purposes. Each country has its own processes for registration, and in Canada some businesses are required to register separately at the provincial level.
4. Apply GST/HST where necessary: Identify transactions that require tax collection and apply the correct rates to those invoices. Though Canada utilizes the reverse charge mechanism for B2B transactions, you should still validate tax IDs for B2B transactions to confirm the customer’s status, but charge tax if a valid tax ID is not provided.
5. File GST/HST returns, make payments, and keep records: Periodically file tax returns with the jurisdictions in which you sell, reporting the tax collected and remitted. Be prepared for foreign exchange conversions and cross-border payments in various currencies. Many countries also have a legal requirement to keep tax records for a certain period of time.

Risks of delaying compliance

Delaying tax compliance can expose your business to various risks:

• Audits: As tax legislation for digital goods is relatively new, audits for international sellers are increasing. Facing an audit for which you are not prepared can result in fees and penalties that can significantly impact your business.
• Paying out of pocket: Regardless of whether your customers pay tax, you are responsible for the tax on the sales you make. If you are audited or register late, you may have to pay the tax out of pocket, along with penalties and fees.
• Reputational risk: When expanding internationally, your compliance with tax rules may be questioned by potential business partners or customers. Failure to comply with tax regulations can harm your reputation and even lead to blocked business opportunities.

To learn more about tax rules and regulations for nonresident businesses around the world, explore Anrok’s VAT index for digital products.