Difference Between Zero-rated And Tax-exempt Products

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In taxation, certain goods and services can as a matter of necessity enjoy special treatment, resulting in them having an either zero-rated or tax-exempt status. While both categories imply a non-existent or zero tax burden, the underlying details that distinguish them hold significant implications for businesses and consumers alike. So, let us talk about these two concepts, their interpretation, impact on pricing, and the underlying policy objectives driving their implementation.

Key Differences

Description

Zero-rated products are goods or services that are subject to a 0% tax rate, meaning that consumers do not pay any tax on these items. However, businesses can still claim a refund for the taxes they paid on the inputs or raw materials used to produce the zero-rated goods or services. Zero rating makes the supplies cheaper as no tax is chargeable while input tax can be claimed. Registered taxpayers who sell zero-rated supplies are entitled to a refund of input tax paid.

Tax-exempt products are goods or services that are completely exempt from any taxation. Both consumers and businesses do not pay any tax on these products, and businesses also do not get a refund for any taxes they paid on the inputs used in producing these goods or services.

Tax Treatment for Businesses

Businesses selling zero-rated products must still charge customers for the goods or services but at a 0% tax rate. They are required to file tax returns and claim refunds for the taxes they paid on inputs.

Businesses selling tax-exempt products do not charge any taxes to customers, and they are not eligible for any tax refunds on inputs used to produce these goods or services.

Refunds and Input Tax Credit

Businesses dealing with zero-rated products can claim an input tax credit for the taxes they paid on their purchases. This allows them to recover the taxes paid on raw materials or inputs used in manufacturing zero-rated goods or services.

Businesses dealing with tax-exempt products cannot claim any input tax credit for the taxes they paid on their purchases. They absorb the tax cost as they are not charging any tax to the end consumers.

Nature of Products

Zero-rated goods or services often include essential items like basic food items, certain medications, or educational services. Governments may choose to zero-rate these items to make them more affordable and accessible to the general public.

Tax-exempted products usually comprise specific goods or services that the government deems essential for societal benefits. Examples include certain healthcare services, educational activities, or religious activities.

Impact on Consumers

Consumers pay a 0% tax rate on zero-rated goods or services, making them more affordable compared to standard rated products (goods or services subject to a positive tax rate).

Consumers do not pay any tax on tax-exempt products, making them cheaper than both zero-rated and standard rated products.

Policy and Administration

Zero-rating is a deliberate policy choice by the government to apply a 0% tax rate to certain essential or socially important goods and services. This is often done to make these products more accessible and affordable to the general population.

Tax exemption is usually implemented for specific reasons outlined in tax laws, such as certain charitable activities, healthcare services, or education. The goal is to promote or support specific sectors or activities.

VAT Reporting and Compliance

Businesses dealing with zero-rated products need to maintain proper VAT records and comply with tax regulations. They must submit tax returns, even though the tax rate is 0%, to claim input tax credits.

Businesses dealing with tax-exempted products also need to maintain proper records, but they may have simpler compliance requirements since there is no tax to account for in their transactions.

Zero-rated vs Tax-exempt Products

BASIS OF COMPARISONZero RatedTax Exempt
DescriptionZero-rated products are subject to a 0% tax rate.Tax-exempted products are not subject to any taxes at all.
Input VATYou can claim input VAT that you pay on your purchases.You can’t claim input VAT for your purchases, nor can you issue a tax invoice for the sale of exempted goods or services.
ExamplesZero rating is done to alleviate the burden on low-income individuals and ensure equitable access to necessary items. Tax exemption is often granted to goods and services that serve a public interest
AffordabilityZero rated products are more affordable compared to standard rated products (goods or services subject to a positive tax rate).Exempted products are cheaper than both zero-rated and standard rated products.  
GoalThe goal is to make these products more accessible and affordable to the general population.  The goal is to promote or support specific sectors or activities.  

Take aways

For a “zero-rated good,” the government doesn’t tax its sale but allows credits for the value-added tax paid on inputs. If a good or business is “exempt,” the government doesn’t tax the sale of the good, but producers cannot claim a credit for the VAT they pay on inputs to produce it. Governments commonly lower the tax burden on low-income households by zero rating essential goods, such as food and utilities or prescription drugs.

If a product or business is “exempt,” the government doesn’t tax the sale of the good, but producers cannot claim a credit for the VAT they pay on inputs to produce it. Because exempting breaks the VAT’s chain of credits on input purchases, it can sometimes raise prices and revenues. Hence, governments generally only use exemptions when value added is hard to define, such as with financial and insurance services.