1. Using Financials for the Americas
  2. Tax Substitutions

Tax Substitutions

Tax substitution concept is widely followed in countries such as Brazil. It refers to transferring the responsibility for paying taxes that become applicable at various stages within the supply chain, to one of the parties involved therein.

In summary, one party within the supply chain (generally the producer) pays the entire tax that becomes applicable till the material reaches the user.

An organization located in location A sells an item to a customer located in the same state. Based on the requirement, ICMS tax is applicable at 18% and the onus of tax substitution is on the original supplier, with a specified value addition of 40% (based on item, nature of transaction and other criteria).

This table provides the required tax treatment in the context of this example.

ICMS-ST

Example

Transaction Line amount 10,000 USD
Value Addition Percentage 40%
Net transaction line amount 10,000 * 1.40 = 14,000 USD
Base ICMS-ST Tax amount (@ 18%) 14,000 * 18% = 2,520 USD
Less: ICMS Tax (@ 18%) 10,000 * 18% = 1,800 USD
ICMS-ST amount 2,520 - 1,800 = 720 USD

This table provides the Tax configuration for ICMS-ST.

Tax Configuration Description
Tax ICMS-ST is applied in addition to the regular tax. So, it must be configured as a separate tax. This is to be calculated on the net value addition that accrues within the supply chain, over the base transaction. So, it is to be configured similar to a differential tax.
Taxable Basis Formula Taxable basis formula should include value addition configuration. Value addition conditions should match with the applicability criteria of the tax.
Tax Calculation Formula Tax calculation formula must be defined for compounding on ICMS tax, with the compounding rule set to Subtract.

This table provides the tax calculation processing for ICMS-ST based on this setup:

Tax Details

Example

Taxable Basis Amount (after applying value addition)

10,000 * 1.40 = 14,000 USD

Calculated Tax Amount (before compounding)

14,000 * 18% = 2,520 USD

Less: ICMS Tax (based on compounding rule)

1,800 USD

Calculated Tax Amount (after compounding)

2,520 (-) 1,800 = 720 USD

Consider these points while configuring ICMS-ST taxes:

  • ICMS-ST has three different variants such as:

    • ICMS-ST Forward: This amount is notified on the fiscal document, along with ICMS tax.

    • ICMS-ST Anticipated: This amount is not notified on the fiscal document. Receiver of the goods or services is responsible for assessing the tax and paying it to the tax authority.

    • ICMS-ST Backward: This tax is applicable for road transportation services availed through a third party transportation company. Party contracting for the transportation services (buyer or supplier) is responsible for assessing the tax and paying it to the tax authority.

  • In situations involving the Forward approach, tax should be configured for application on both purchase and sales events. In case of situations involving the Anticipated or Backward approach, tax conditions should cover only purchase events and it should get applied as Self-assessed tax.

  • To apply this tax as self-assessed, the tax registration party must be configured to derive Ship-to Party or Bill-to Party. Further, tax registration record associated with the Legal Reporting Unit should be marked as Self-assessed.

  • Taxable basis amount for ICMS-ST is based on either estimated sale price (if notified by the tax authority) or a value addition percentage. If transactions exist with a combination of these criteria, then different taxable basis formulas should be defined with Price Thresholds and Value addition details. Rule conditions could be configured to pick the appropriate taxable basis formula.

  • If taxable basis formula is based on price thresholds, then it should be configured with Fixed Price option. Also, the precedence levels should be appropriately marked for processing price thresholds or value addition, especially when the evaluating criterion is similar. As done in case of rule order evaluation, most commonly used transaction criteria should be set with least precedence numbers.

  • ICMS-ST is calculated along with ICMS Tax. So, the tax applicability conditions for both these taxes must match. In addition, ICMS-ST should include criteria relating to Forward or Anticipated or Backward approach for processing specific treatment on this tax based on transaction details.

  • ICMS-ST represents differential tax amount between what is legitimately payable by the party in the regular course of business and what could be the total tax that becomes payable by all the transacting parties within the supply chain. This value can be achieved through the configuration of tax calculation formula, with compounding rule for subtracting ICMS tax.

  • As ICMS-ST involves compounding on ICMS tax, the compounding precedence specified on the respective tax regimes or taxes must support it, the precedence number for ICMS must be less than ICMS-ST.