(Canada Only) 50% Meals and Entertainment recoverable; tax code setup help?

[upfortier]

Background: in Canada meals and entertainment expenses are only able to be deducted at 50%. This extends to the sales tax (GST/HST) collected: 50% is recoverable as an Input Tax Credit, 50% is an ‘expense’.

Typical bookeeping software instructions I have found say to create (assuming a 13% tax) a 6.5% ‘liability’ tax and a 6.5% ‘expense’ tax. Example instructions I found: QBO Canada Sales Tax Setup - Meals (a major competing paid Online Bookeeping Software suite is mentioned in the article).

When I tried to do something similar Manager did not seem to allow creating an ‘expense’, only ‘liabilities’ tax, but perhaps there are some other steps/settings I have missed. I would rather not reconcile 50% of the tax value using the journal, is there a better approach or some other way to handle this?

Thanks!

EDIT: While I said ‘sales tax’ here, I think the GST/HST is better understood as a ‘VAT’

[Tut]

This seems like an horrendous amount of work. I’m only minimally conversant with Canada’s tax laws, so what I say may not apply. But most sales taxes are not offsettable. That is, amounts you owe the government because you collected sales tax from your customers are not reduced by amounts your paid to suppliers. So in most jurisdictions with sales taxes instead of value-added taxes, no tax code is applied on purchases. Instead, tax is included in the purchase amount entered. That way, the Tax payable liability account includes only the tax you collected from customers on behalf of the government. When you remit the sales tax and post it to that account, the account’s balance is reduced by the amount remitted.

There is a further issue involved, and that is the difference between tax accounting and financial accounting. Meals and entertainment expenses, including taxes on them, may not be fully deductible for income tax purposes, but they can still be legitimate business expenses. Proper recording of financial performance should include them at their full amount. Adjustments necessary for tax filing do not affect true profitability. If you paid tax on a business meal, your bank or cash account is reduced by the full amount of the meal and tax.

Depending on your tax jurisdiction, some tax preparation software (including Intuit’s own TurboTax), requires you to enter the full amount of meals and entertainment expenses. The tax software then factors downwards by the appropriate percentage to calculate the tax deduction. (50 percent is a common reduction where limitations are imposed by law.)

All this is a long-winded way of saying you may not require any special accounting in Manager at all. If the sales tax is not offsettable, you would include tax in the price, not apply a tax code. And either way, you should record transactions at full amounts to obtain an accurate picture of performance and match cash/bank account transactions. Adjustments for tax filing purposes are off-book, not actual transactions of your company.

[upfortier]

Perhaps there is a misunderstanding: colloquially in Canada the GST/HST/QST is called a ‘sales tax’ (because it is added to all sales), but based on your description/understanding of a difference it seems to be a ‘value added tax’ (What is the difference between sales tax and VAT?), as it is collected by all entities along the entire supply chain.

Since most of your answer seems to be predicated on the assumption that HST is a ‘sales tax’ and not a ‘VAT’, may I rephrase the question in the context of a VAT?

For reference: Government of Canada page on input tax credit rules for GST/HST https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/gst-hst-businesses/gst-account/input-tax-credits.html)

[Tut]

Thanks for the link.

OK, I am answering in broad terms. You are going to need to create custom tax codes. If your tax has multiple components, see this Guide: Work with multi-component custom tax codes | Manager. Even if it doesn’t, there are no built-in tax codes for Canada.

Then, you’ll have to break your meals and entertainment expenses into multiple lines on sales and purchase transactions. Put 50% of the purchase on one line and apply your regular tax code for your province, as set up in your custom code. The tax is at full rate because your apportionment of expense is being applied to the purchase amount. Thus, the tax will be apportioned, too. Post this line item to an expense account named something like Deductible meals & entertainment.

Put the other 50% of the purchase on another line and apply no tax code at all. Post this line to an expense account named something like Non-deductible meals & entertainment.

Add the balance of the transaction, which will be the unallowed tax, to a third line. Also post this to Non-deductible meals & entertainment. Or, you could just combine this amount with the non-deductible 50% of the purchase.

This way, all your expenses and taxes paid are reflected in your records and match bank or cash transactions. So your true profit is calculated. But the deductible and non-deductible portions are visibly separated for tax filing. And the Tax payable account is only reduced by by 50% of the tax paid on limited purchases for meals and entertainment. That keeps the offset amount correct.

[upfortier]

You’re right, that will work, really makes bookeeping meals a hassle.

[upfortier]

How does one make a feature request? In this case it would be to allow ‘taxes’ to be ‘expenses’ not just liabilities. I don’t mind creating a new thread.

[Brucanna]

@upfortier

to allow ‘taxes’ to be ‘expenses’

You just leave the non liability taxes within the expense figure - meal for 100 + 15% Tax

[Tut]

@upfortier

allow ‘taxes’ to be ‘expenses’ not just liabilities.

Taxes can be expenses. As I explained in my earlier post, you allocate the non-deductible tax to an expense account, either as a separate line or by combining with the non-deductible portion of the meal. If you like, you could even create a separate expense account for it, Non-deductible meals tax or such. The reason you don’t want to use a tax code is because that would allocate the tax to Tax payable as an offset to tax collected from customers. And that’s not how your tax works.

[upfortier]

@Tut

@upfortier

allow ‘taxes’ to be ‘expenses’ not just liabilities.

Taxes can be expenses. As I explained in my earlier post, you allocate the non-deductible tax to an expense account, either as a separate line or by combining with the non-deductible portion of the meal. If you like, you could even create a separate expense account for it, Non-deductible meals tax or such. The reason you don’t want to use a tax code is because that would allocate the tax to Tax payable as an offset to tax collected from customers. And that’s not how your tax works.

I should have clarified: a tax as an expense from within the tax code setup function itself. Of course I can take the meals subtotal, split it into two, add 1/2 tax to one line and direct this into a nonrecoverable account, claim the tax as an offset at 50% rate on the other line and add a third and fourth line for gratuity, itself 1/2 recoverable and 1/2 not.

To make sure I understand correctly, I believe I need to track expenses like this (assumes a $100 meal, 13% HST and a $15 gratuity:

[upfortier]

To clarify what I meant when I said ‘taxes as expenses not just liabilities’ I meant in the ‘tax code’ creation page, here is a picture visually showing what I was trying to describe:

If this was present it would make the expense go to this (I think):

[Tut]

Your 4-line breakdown looks correct to me, assuming you are recording this on a payment form, which is always tax-inclusive. (A purchase invoice for a restaurant would be fairly unusual.)

But as I said before, this seems like an horrendous amount of work. This is especially true when you consider it would need to be done, not just for client dinners, but for every meal while on business travel, etc.

I would consider a scheme with only the full-rate tax code. First, I would set up three expense accounts:

• Tax-inclusive meals
• Non-taxable meals
• 50% Meals

The only purpose for the first two is to simplify splitting at the end of the accounting period. Otherwise, they could be a single account.

I would enter a meal on 2 lines, distinguishing only the portion that was taxable from the portion that was not by initially posting those two lines to Tax-inclusive meals and Non-taxable meals. Then I would make one journal entry at the end of each tax filing period to move half of both those accounts (for the accounting period) to 50% Meals. Here is an example for a 100 taxable meal, 10% GST tax rate, and 15% non-taxable gratuity.

The payment is entered, including the tax in the amount on the Tax-inclusive meals line. No tax code is selected. (Leading numbers in Account fields in this example are account codes used to group accounts together for display.)

On the balance sheet, Tax payable has not changed, because no ITC tax amount has so far been entered. The transaction is, to this point, being treated as though the tax were non-offsetting:

and the expenses show up on the P&L:

At the end of the accounting period, this journal entry is made. Note that the full-rate tax code is applied only to the debit to 50% Meals from the Tax-inclusive meals account:

Now the balance sheet shows a debit balance in Tax payable, representing the ITC on 50% of the taxable meal charge. (If there were normal tax collections from customers in this account, the balance would probably be in credit.)

The P&L shows the adjusted expense accounts:

In this example, 55.00 plus 7.50 represent your total, non-deductible meals expenses, including taxes that could not be used as ITC’s. 57.50 is the amount spent that can be deducted. Of course, the missing 5.00 from the restaurant bill of 125.00 went to the Tax payable account as an ITC.

The critical step with this approach is that the only place the tax code is applied is to one debit line in the journal entry at the end of the accounting period. And the only other extra step is the need to split the restaurant payment into two lines, but you would have to do that with the approach you were trying to get to anyway. And that’s a lot better than splitting every meals payment into four lines.

[upfortier]

@Tut thanks, that approach is simpler. Fortunately I am in my 1st accounting period and have only two transactions of that type to adjust.

This is fine for now. I would prefer to not use the Journal, but without Canada-specific tax codes or the feature I mentioned this is the only approach that does not involve tripling my bookeeping effort it seems.

Manager is a one maybe two man project with @lubos as the dev team right? Unless this is some trivial change I suspect there are more … profitable features to prioritize. Tax codes for California spring to mind; California being the 6th largest economy in the world and all that.

[Tut]

There are no built-in tax codes for anywhere in the USA or Canada. The entire structure of Manager’s tax module is built around offsettable VAT systems. That’s not surprising, considering that is what is used in most of the tax jurisdictions of the world. At least you are dealing with only one harmonized tax code (based on what you’ve said). Things would be more complex if you were doing this with separate provincial and federal codes.

Now imagine a jurisdiction in the USA with multi-component sales tax for state, county, city, and special tax jurisdictions. The setup is a nightmare and reporting for the separate jurisdictions, which may have different filing schedules, is essentially non-existent. Then add the complexity of different customers being exempt from one or more components based on where the goods or services are delivered and whether the business has a presence in that location. Now factor in tax exemptions for certain categories of goods and on customer category. So there is a four-dimensional space that determines applicability of each component of the code, easily 12 to 20 decision criteria for every line on an invoice. Then tear your hair out when one of the jurisdictions changes a tax rate and you have to replicate the entire structure. Or several of the jurisdictions change rates with different effective dates. Suddenly, a period-ending journal entry doesn’t look so bad.

[upfortier]

There is a reason why I did not ask for Canadian tax codes to be added, and that complexity is the reason.

Previously exactly what you said was the case in Canada + US and the problems created for tax accounting, was the case. Back in 2010 the province of Ontario combines the provincial “sales tax” (PST, a non-recoverable sales tax; but exempt entities would not be charged the PST if they were not consuming the item) with the federal Goods and Services Tax (a VAT) to turn both into a VAT. For every line item on an invoice you needed to determine if it was GST, PST or both GST and PST taxable. Books, accounting services, gasoline and feminine hygene products were exempt from PST. Basic foods were exempt from both GST and PST. Many retailers just have two HST lines on their receipts (HST 5% and HST 8%) to keep it simple.
Thd old says: Provincial Sales Tax, or B.C. (Washington’s Hat or Alaskas Chair) today.

HST makes it much simpler (apart from this 50% expensable meals + entertainment allowing for 50% HST recoverability combined with the (annoying to bookeepers?) gratuity to add to all meals… because?

NB: If I make purchases in another provice, I do need to track that separately. For example QST (the Quebec VAT) would be non-recoverable, but the HST portion would be. In this case, it’s easy: create a 5% GST tax and use that. Same for accounting services, books, tampons/pads and everything else that has the provincial portion of the HST exempt.

Thanks for your help. I hope lubo sees this and adds the feature, but if it isn’t in the build on Tuesday, I won’t sweat too much.