Considerations for Tax Exemptions

A tax exemption applies to a specific customer or to a combination of customer and specific product.

For example, in the United States, the Federal Government acting as a customer is exempt from tax on direct sales. Many states provide exemptions on sales of necessities such as food and clothing.

To set up tax exemptions for a third party, you must complete the appropriate tax exemption setup for the tax regimes and taxes concerned. Create a separate record for each tax exemption that applies to the third-party customer or customer site. The tax determination process applies the tax exemption to the transaction line based on the tax exemption setup and tax handling specified on the transaction line.

Tax Exemption Setup

Before you can create a tax exemption record, you must enable the tax exemption options at the appropriate levels:

Set the Tax Exemption Override Control profile option. It controls the display of tax handling on the transaction line to apply and update customer tax exemptions to transactions.
Set the Allow tax exemptions option at the levels that correspond to the tax exemption. For example, if the tax exemption refers to the tax status of a particular tax, then you must set this option at the tax regime, tax, and tax status levels.
Set the Allow exemptions option in the configuration owner tax option for each event class for which calculation based on tax exemption is to be enabled. For the exemptions party basis select whether the bill-to party tax exemption records are to be considered or the sold-to party tax exemption records. In some cases the sold-to party could be different from the bill-to party.

Tax Exemption Record

A tax exemption record identifies the nature of the tax exemption, the configuration owner, and tax regime, and, where applicable, the related tax, tax status, tax rate, and tax jurisdictions to which the tax exemption belongs.

During the life of a tax exemption, the tax exemption status can often change. The possible statuses are: Primary, Manual, Unapproved, Discontinued, and Rejected. Because the status of the tax exemption affects its applicability on the transaction line, you must update the tax exemption record each time the status changes. These rules apply to the status of the tax exemption:

Tax exemptions with a status of Primary apply to all transactions of the customer or customer site.
Tax exemptions with a status of Manual or Unapproved apply to specific transactions of the customer or customer site.
Tax exemptions with a status of Discontinued or Rejected are not considered during tax calculation.

You also specify the method of calculating the tax exemption percentage on the tax exemption record:

The Discount or surcharge type decreases or increases the original rate by the percentage you enter.

If the discount is 15% off the standard rate and the standard rate is 10%, enter 85 as the tax exemption percentage. This defines a discount rate that is 85% of the original 10%, or 8.5%.

If the surcharge is 10%, enter 110 as the tax exemption percentage. This defines a surcharge rate that is 110% of the original 10%, or 11%.
The Special rate type replaces the original rate with the percentage you enter.

Enter the special rate percentage that replaces the standard rate. If the original rate is 10%, and the special rate is 5%, enter 5 as the tax exemption percentage.

Tax Exemption Applied to the Transaction Line

You use the Tax Handling field on the transaction line to select the applicable tax exemption value. Tax exemptions are processed in different ways depending upon the value you select:

Require: The customer is required to pay the tax. Tax exemptions do not apply to the transaction line, even if defined.
Exempt: Enter the tax exemption certificate number and the customer tax exemption reason. Tax exemptions are processed in this way:
1. Consider tax exemptions with a status of Primary, Manual, or Unapproved.
2. Verify that the transaction date is within the tax exemption effective date range.
3. Verify that the transaction tax exemption reason and tax exemption certificate number match the tax exemption reason and certificate number. If you do not enter a certificate number, the tax determination process still looks for a matching tax exemption.
4. If the tax determination process doesn't find a tax exemption matching these conditions, it creates a tax exemption with the status Unapproved and 100% discount.
Standard: This tax handling is for exemptions of the Primary status only. You do not have to enter the tax exemption certificate number or customer tax exemption reason.

The tax determination process looks for a tax exemption with the Primary status and an effective date range that includes the transaction date. If more than one tax exemption applies, the most specific tax exemption is used, in this order:
1. Customer and product tax exemption for tax rate and tax jurisdiction.
2. Customer and product tax exemption for tax rate.
3. Customer and product tax exemption for tax status and tax jurisdiction.
4. Customer and product tax exemption for tax status.
5. Customer and product tax exemption for tax.
6. Customer only tax exemption for tax rate and tax jurisdiction.
7. Customer only tax exemption for tax rate.
8. Customer only tax exemption for tax status and tax jurisdiction.
9. Customer only tax exemption for tax status.
10. Customer only tax exemption for tax.
Exempt, manual: You manually enter a certificate number and exemption reason. The application process creates a tax exemption with a status of Unapproved and a 100% discount is applied.

Note: The application first checks the customer site party tax profile for the exemption records. If there is no exemption record defined within the site, then it checks the customer party tax profile.

After applying tax exemption to a transaction line, the tax determination process calculates the tax rate using the tax exemption type. The tax exemption type is defined in the tax exemption record. The sequence of the tax rate value determination is:

Determine the basic tax rate through the Determine Tax Rate rule type or by the default specified for the tax.
Apply exception which is based on the product.
Apply tax exemption which is based on the party (customer) and its relationship with the transacting organization (legal entity or business unit). Optionally, it can be based on a specific product.

For example, the tax rate determined is 6%, the special rate for a tax exception is 5%, and the tax exemption defined is a 2% discount. The tax exemption discount is applicable to the tax rate after the tax exception. Therefore, the 5% tax rate is modified by a 2% discount (5% * (100%-2%) = 4.9%). If the tax exemption defined is of the rate type of Special rate then the special rate is substituted and the applicable tax exception has no impact.

For manual tax lines, no additional processing is performed and tax exemptions are not considered. A manual tax line suggests that you have specific business requirements for a particular transaction to apply a manual tax. No additional processing is performed for manual tax lines to avoid any applying conflicting or inconsistent values to the user-entered tax line. The tax calculation on a manual tax line is the standard formula of tax amount is equal to the taxable basis multiplied by the tax rate.