Sales Tax Settings in Xero

A question came in through the "tax question" section that is bookkeeping related. I get asked this a lot so I figured I would answer as a post.

The question was:

"In tax software, when setting up rules for a bank feed to follow, there is an option on spend rules to set a tax rate when allocating to accounts. Is it normal to track what tax you paid on purchases?

Or should spending rules be applied with 0% tax rate.

I ask because I obviously want to be doing this correctly, but also, if tax rate should NOT be applied, then the rules can be set up faster without taking consideration of the store location when a vendor has multiple, and I wont have to set up a bunch of tax rates for every purchase location."


The answer requires a bit of Xero history. Xero was originally designed in New Zealand and matches what I call the commonweath tax system that you'll find in Australia, Canada, the UK and europe. In those places you can offset your sales taxes owed by sales taxes spent in your business. In America, that doesn't apply, unless you are a reseller, and even then you get a sales tax exemption.

So, the way to deal with this in Xero is to make sure that sales tax on purchases are not tracked, or set at 0% when setting up rules and accounts for purchases. When setting up sales rules, then you definitely need to set the applicable sales tax rates.

If you start tracking sales taxes on purchases, Xero will track them in a manner that it assumes you can use them to credit your taxes taxes owed. That will cause problems.

- Avery