Concepts
Tax code
A tax code is a label applied to each transaction in your accounting records to show whether GST applies and how it should be reported, which then feeds into the BAS.
A tax code is a short label that you or your software attach to each sale, purchase or other transaction to tell the system how to treat GST. Typical codes distinguish between transactions that include GST, those that are GST-free, those that are input-taxed and those that are outside the GST system altogether, such as wages. The names and abbreviations vary between software packages, but the underlying categories are the same.
Tax codes matter because the BAS is built from them. When you run a BAS report, the software adds up the transactions by code to work out figures such as total sales, GST collected, purchases and GST credits. If a transaction has the wrong code, the figures reported to the ATO will be wrong, which can mean overpaying GST, claiming credits you are not entitled to, or underreporting sales.
Choosing the right code requires understanding the nature of the transaction. A sale of ordinary goods by a registered business generally carries GST. Fresh fruit and vegetables are generally GST-free. Residential rent and bank fees are generally input-taxed. Wages are outside the system. On the purchase side, a business expense with GST in the price normally gives rise to a credit, while a purchase from a supplier that does not charge GST gives no credit. Capital purchases are coded separately because they are reported at a different BAS label.
Software may suggest a default code for each account or supplier, which is a helpful starting point but should be checked. The same supplier might invoice different items with different treatments, such as a supermarket receipt that includes both GST-free groceries and taxable items. Where the transaction has a mix, it may need to be split across codes. Reviewing a list of transactions by code before lodging often reveals mistakes.
Tax codes are also used for other purposes, such as separating private purchases or flagging items that need to be apportioned. For a business that is not registered for GST, codes are usually set up so that GST is not tracked at all. If you later register, you will need to switch on GST in the software and ensure the new codes apply from the correct date to avoid confusion.
A common misunderstanding is that a tax code determines the tax treatment. It does not. It records the treatment, and the law determines what the treatment should be. If the code and the law disagree, the law prevails. Another is copying a code from an earlier transaction without checking whether it still fits. This is general information only, so confirm how this applies to you with the ATO or a registered tax professional.
Worked example
A grocer buys $1,100 of cleaning supplies, including $100 GST, and $800 of fresh vegetables, which are GST-free. The cleaning supplies are coded as a purchase with GST, giving a $100 credit. The vegetables are coded GST-free with no credit. If both were wrongly coded as including GST, she would claim an extra $72.73 credit, calculated as $800 divided by 11, that she is not entitled to.
Practical tips
- Run a transaction report by tax code before lodging your BAS and look for anything unusual.
- Split mixed receipts across codes, such as groceries that include both GST-free and taxable items.
- Do not rely on default codes alone. Check each new supplier and account.