Value Added Tax

It is always beneficial to first understand the basic concept of value added tax before going into any
setups of VAT. Tax is a charge by the government. VAT is a form of indirect tax. Sales tax is a tax
applied on sale of goods:

1. Within the state.

2. From one state to another.

The former is associated with VAT and the latter is associated with CST. Tax payable on sales is
‘Output Tax’ and tax paid on purchases is ‘Input Tax’.

The following examples are related to ‘India’ which might be useful in understanding the VAT
concept.

Example 1 – Suppose manufacturer buys raw materials worth Rs. 100 @ 4% VAT. Manufacturer sells
goods to distributor for Rs. 300 at same rate. The distributor sells it to the retailer or the shopkeeper
for Rs. 500 at same rate. The retailer sells it to the final customer for 800 at same rate.

From To Sales Price Output Tax Input Tax VAT payable

X Manufacturer 100 4 NA 4
Manufacturer Distributor 300 12 4 8
Distributor Retailer 500 20 12 8
Retailer Customer 800 32 20 12

Example 2 - This example will make it clear as to why value added tax was introduced.

Manufacturer X Distributor (y) Retailer (z) Customer (X)

RM (Direct and 80 110 (80 + 20 + 10) 220 (80 + 20 + 10 330

indirect + 90 + 20)
expenses)
Profit 20 90 80 -

Sales Price 100 200 300 -

Sales Tax (10%) 10 (8 + 2) 20 (8 + 2 + 1 + 9) 30 (8 + 2 + 1 + 9 + -

2 + 8)
Invoice Price 110 220 330 -

Paid to 10 20 30 -
government
 Inter State Vs Intra State Sales
Case 1: When there is sale of goods from one state to another state, it is termed as
interstate sale of goods. Example: Delhi and UP are two different states in India. Sale of
goods from state 1 (Delhi) to state 2 (UP) is termed as interstate sales.

Delhi Inter-State Sales UP

Case 2: When there is sale of goods within the state, it is termed as Intra-State sales. Example: A
dealer in ‘Delhi’ sells goods to another dealer in ‘Delhi’. VAT is applicable in Intra-State sales of goods
and not inter-state sales of goods.
 Setups related to Value Added Tax
The setups to be done for VAT implementation are explained below with the help of
screenshots:
1. Identify the tax method – The tax method can be classified into ‘Item Method’ and
‘Account Method’. Before, defining the tax codes and tax rates the method needs to
be determined.

Under the item method the system looks for the tax code defined at: Item,
Customer, Customer Site and system option (order matters).

Taxes can also be controlled from ‘Revenue Account’ in such a way that chart of
accounts is VAT compliant. While navigating to the GL tax options window in general
ledger, you can assign tax codes to account. In this case when receivables imports
the transactions the tax code will default.

2. Define tax codes and tax rates – Once the tax method is determined, the code and
rates must be defined by navigating to system options in receivables module.

- Multiple tax codes can be defined for tax type ‘VAT’.

- Tax code can be inclusive and exclusive. Former means that it will calculate
the tax amount for the invoice line and include it in the receivables lines.
- The tax codes that are defined here are included in the tax groups.
- The system will not let you enter a tax rate and more than one tax code for
tax type ‘Location based tax’.
- A tax code can have a positive as well as negative sign. Receivables will credit
the tax amount and debit the tax amount for tax codes with positive and
negative signs respectively.
- Location based tax codes are always ‘Tax Exclusive’.
It should be noted that invoice will have tax lines even if the rate was zero and the
distribution lines would be posted to general ledger with zero amount.
3. Defining VAT through account method – Here, the tax codes needs to be defined in
GL tax options as stated earlier where tax code will be assigned to revenue account.
The following setup needs to be done to make sure that tax code is derived from
revenue account:
- ‘Enforce tax from revenue account’ should be set to ‘Yes’ in system options in
receivables module.
- ‘Allow tax code override’ option should be set to ‘No’ in GL tax options in
general ledger module.
Is ‘Allow tax code override’ Is enforce tax from revenue Will receivables pull the tax
checked/unchecked account checked/unchecked code from revenue account?

4. Use of tax groups – Tax groups can be used under two scenarios namely: If tax
method is not account based and VAT rates are calculated using a combination of
inventory item and ship-to location. Instead of assigning a tax code to item, tax
groups can be utilized if items are shipped to multiple countries to collect different
taxes.

5. Use of item method – Here, assign the tax codes / tax group to each inventory item.
Inventory item templates can also be used to define items. In this case receivables
will automatically assign the correct tax code or the tax group. It is recommended
that separate template be created for each VAT classification. The five basic classes
of VAT are: Standard, reduced, luxury, zero and exempt.

6. Define Sales Tax Location Flexfield Structure – This is required to determine the tax
rates as well as to control which fields of customer address is required while entering
the domestic address. Certain structures are already defined in ERP.

No Validation – Country is usually recommended for value added tax.

State - City
State – County – City (Generally used for US sales tax)
City
Province
Province – City

7. Defining tax preferences – The tax is also effected by the system options explained
below :

Tax Option available Settings (Recommended)

Tax Method VAT
Tax Code Default

Address Validation No validation

Compound Taxes No
 Invoice Printing Itemize and summarize
Tax Registration Number Company’s tax registration number
(Receivable will print this number and it
can be changed while printing)
Rounding Rule Nearest
Reporting Currency Functional Currency
Default Country Home country

How Tax Rounding System Works

First, choose a calculation level (line or header) to calculate tax for each line or
invoice for each rate.

Secondly, choose a rounding rule from up, down and nearest. Up rounds the tax
calculation to greater amount, down rounds the tax calculation to smaller amount
and nearest rounds the tax calculation to the nearest decimal / integer.

Let us see above in action:

Rule Unit Price (in INR) Rounded to

Up 5.444 and 5.445 5.45
Down 5.444 and 5.445 5.44
Nearest 5.444 5.44
5.446 5.45

Lastly, if you uncheck the ‘Allow Override’, receivables will disable the tax calculation
and tax rounding at customer and customer site level.

8. Using tax defaults – Use the system options (Receivables) to determine how output
tax is computed and use system options (Payables) to determine how input tax is
calculated. The setup is different under item and account method which is explained
below:

Item Method

Tax Code Yes/No Hierarchy No.

Enforce tax from No NA

revenue account
Customer site Yes 1
 Customer Yes 2

Product Yes 3

Revenue account No

System options Yes 4

Account Method

Tax Code Yes/No Hierarchy No.

Enforce tax from Yes NA

revenue account

Customer site No

Customer No

Product No

Revenue account Yes 1

System options No

There can be customers who are exempt from paying tax (in part or full) and
items/products that are exempt from tax (in part or full). In such a case customers
and items can be assigned a tax code that would exempt them from tax.

9.

10. Saving the system options – Once you save the system options three concurrent
programs will be fired. These programs should be completed successfully / without
any errors.
11. Tax Exemptions – As stated earlier once the tax codes and their associated tax rates
are defined, the codes will be assigned to item, customer or customer site. If the
customer needs to be exempted from paying VAT, assign tax code at customer level
and if only particular customer sites needs to be exempted from paying VAT, assign it
customer site level.

12. Transaction types and auto-accounting – To ensure that completed invoices show
value added tax for each transaction type, the ‘Tax Calculation’ field should be set to
‘Yes’ in the receivables transaction types window. Auto-accounting can be used to
determine how the receivables will derive the ledger account for VAT.

13. Tax Profile options – Certain tax profile options need to be setup and the following
settings are usually recommended:

Profile option - Tax: Allow Manual Tax Lines

Setting – Yes
Reason – Countries might have many additional tax lines.

Profile option – Tax: Allow Adhoc Tax Changes

Setting – Yes
Reason – To update the tax manually.

Profile option – Tax: Allow override of tax code

Setting – Yes
Reason – Allows you to override the existing tax code.

Other tax profile options will be setup depending upon the requirement of the
business: Tax: Allow override of customer exemptions, Tax: Invoice freight as
revenue and Tax: Inventory item for freight.

Profile Options Features

Tax: Allow Adhoc changes This profile option is only applicable to

tax type sales or VAR with Ad Hoc flag
set to ‘Yes’ and is not applicable to
‘Location based’ type tax.
Tax: Allow manual tax lines You might want to set this option to
‘No’, when there is outside tax vendor
installed and vendor manages tax audits.
Tax: Allow override of customer The tax handling field in the lines
exemptions. window can be accessed if this option is
set to ‘Yes’ and you can handle
exemptions for each of your transaction
lines. Standard can be used, if any rates
 can be used assigned to customer or site
for tax calculation. Use ‘Require’ to
require tax on your transaction lines.
Tax: Allow override of tax code If you override the system derived tax
code, new rates and code will be used by
receivables to determine tax for the
transaction.
Tax: Invoice freight as revenue

14. VAT Reconciliation Report Set – To compile VAT return, it is recommended to

prepare a VAT Reconciliation report set that includes the following reports: VAT
reconciliation report, Customers with invoices of zero VAT and no VAT registration
number and VAT exception report. The setting for parameters would depend upon
specific requirement of each country.

The following are the important features provided by receivables for successfully
implementing Value Added Tax., many of which have been covered above.

- VAT can be controlled through item and destination country.

- VAT can also be controlled through revenue account.
- Receivables lets you compile periodic VAT returns with the help of country-
specific VAT reports.
- Integration of VAT implementation with legacy systems.
- VAT amounts can be rounded at header/line level.
- Inclusive as well as exclusive VAT amounts can be calculated.
- Invoice/transactions can be printed inclusive or exclusive of VAT.
- Changes in rates for a particular tax code can be controlled easily.
- Customers and sites can be exempt from VAT.
http://docs.oracle.com/cd/A60725_05/html/comnls/us/ar/calcta03.htm#n_itmcusex

http://docs.oracle.com/cd/A60725_05/html/comnls/us/ar/calcta02.htm#n_taxstp

http://docs.oracle.com/cd/A60725_05/html/comnls/us/ar/stptax04.htm#t_exempt