“Excise Tax” and “India Localization” – A simpler explanation.
Objective of this article:-
Explain “Excise” and related taxes in a simple way...
OR
The Fundamental concept behind how excise works…
Intended audience of this article:-
·
People who wish to get a generic idea on what “Excise” Tax and related topics
are all about.
·
Oracle, SAP and other ERP consultants who wish to implement modules
generally referred to as “India Localization” – and these are mostly software
modules which involve recording and calculating taxes that a manufacturing
organization has got to pay to the concerned authorities.
Now, one problem which tends to happen in the IT service sector, at least in
India is this – the chap hired by the IT company would be either an engineering
graduate or an MBA, and he/she never had “Taxes” as an academic topic (engg. grads, at least.. ). Consequently,
their domain knowledge related to taxes ranges from very little to nothing at
all. The next logical thing they’d do is search on the internet for any
material which explains with simplicity as to how they work.
From how much I’ve tried, I’ve always ended up getting too much info!! The only
problem was, the explanation invariably always seemed too complicated for me to
grasp!!
However, I was fortunate. I finally found a few people who did
just that for me – they finally made me understand the topic!! A big thank you
to them!! J
Just thought that I shall try and explain Excise Tax and related stuff
in a generic way….. probably just try and explain the fundamental concept
involved in it….. and that’s what I intend to do so here below….
So to Start :-
Let’s consider that there’s a manufacturing plant located close to your
home, and they’re manufacturing a discrete product called “Finished Good”, or
“FG” in short.
This FG that they manufacture is made using an item called “Raw
Material”, or “RM” in short.
They perform a few operations on RM, and these operations convert this
RM into FG. A simple representation of the same is as in this figure below:-
The obvious first step will be to buy RM…….
Let’s say that exactly 1 unit of FG needs to be manufactured. So, for
doing this, the first activity that the manufacturing plant needs to do is buy
exactly 1 unit of RM .
To be able to easily convert numbers into percentages, I’ll assume that
the “assessable cost” of 1 unit of RM is Rs 100/-.
What do I mean by assessable cost? It can be described as the price that the
supplier of RM wants to receive and keep for himself end of the day. The
assessable price is the price which is absolutely free from any form of tax.
Whatever tax needs to be calculated and paid, will be done so by considering
this Rs 100/- as the base price.
Now, these two items that I’ve defined as RM and FG are “Excisable
Items”. This means that a government authority called “Excise Authority.. “
already have a rule defined in their rule book which states that items RM and
FG are standard items, and they would charge a tax on these two items called
“Excise Duty”.
(Kindly note that all the numbers I’ve considered here are generic and
are used only to explain a concept. The actual percentage of the tax could be
different.)
Coming back to buying/ procuring of RM from the supplier, here below is
a list of taxes that will be charged on it’s assessable cost of Rs 100/- per
unit:-
1.
Basic Excise Duty (B.E.D) = 10% of Assessable Cost.
2.
Higher Education Cess (H.E.C) = 2% of Basic Excise Duty.
3.
Secondary Higher Education Cess (S.H.E.C) = 1% of Basic Excise Duty.
All three above
taxes that I’ve defined are “Excise Taxes”. It’s just that they’re split into 3
components. Apart from this, generally there are about one or two more taxes
which are known as VAT and CST.
VAT and CST are not “Excise” taxes. In general, VAT is a tax charged by the
State Government and CST is a tax charged by the central government. . For
simplicity purpose, we’ll forget them for now. As of now, I’ll consider all
other taxes like VAT, CST, etc as non -existent. We’ll consider that, only the
three taxes that I’ve mentioned above, are there.
When the Manufacturing Plant purchases 1 unit of RM from their supplier, they
would receive a Bill which looks similar to this:-
|
ABC Supplier Ltd.
|
|
Sl No.
|
Item Name
|
Qty
|
Cost
|
Currency
|
|
1
|
RM
|
1
|
100
|
INR
|
|
10% Basic Excise Duty
|
|
10
|
INR
|
|
2% Higher Edu. Cess
|
|
0.2
|
INR
|
|
1% Sec. Higher Edu. Cess
|
|
0.1
|
INR
|
|
|
|
|
|
|
Total
Bill Amount
|
|
110.3
|
INR
|
I believe the view of this bill is self explanatory. However, to prevent any
sort of confusion, here's an explanation of the same:-
Cost of RM ("assessable
value") = Rs 100/-
10% Basic Excise Duty is applied on
Assessable vaue = 10% of Rs 100/- = Rs 10/-
2% Higher Edu. Cess is applied on the
Basic Excise Duty = 2% of Rs 10/- = Rs 0.2/-
1% Sec. Higher Edu. Cess is applied,
again on the Basic Excise Duty = 1% of Rs 10/- = Rs 0.1/-
So, the Total amount that the manufacturing plant is paying = Rs ( 100 +
10 + 0.2 + 0.1) = Rs 110.3/-
As you can see, out of Rs 110.3/-, Rs 10.3 is “excise tax” and Rs 100/- is the
price of RM. But here, when the manufacturing plant is paying the above bill,
they’d pay the full amount of Rs 110.3/- to the supplier. The point I’am trying
to drive is, the manufacturing plant cannot tell the supplier that they’ll pay
them Rs 100/- and pay up the remaining amount of Rs 10.3/- directly to the
Excise Department. The manufacturing plant has got to trust the supplier that
the Rs 10.3/- which he is paying to the supplier will inturn be paid to the
“Excise Authority… “ by the supplier.
Now, considering that the purchase of RM by the manufacturing plant is completed,
let’s assume that they take about 3 days to perform the required operations to
convert RM into a FG.
So, 3 days later, the FG is ready. Again, the process repeats. The
manufacturing plant does their mathematics and decides that their “assessable
cost” of FG is Rs 200/- (let’s assume for
calculation purposes… ).
They’ve also found a customer who has found this “assessable” price of Rs 200/-
to be competitive in the market and has decided to purchase it for this price.
As I said, the process repeats. The manufacturer sells the FG to their customer
and gives them a bill which looks similar to the figure below:-
|
FG Manufacturer Ltd.
|
|
Sl No.
|
Item Name
|
Qty
|
Cost
|
Currency
|
|
1
|
FG
|
1
|
200
|
INR
|
|
10% Basic Excise Duty
|
|
20
|
INR
|
|
2% Higher Edu. Cess
|
|
0.4
|
INR
|
|
1% Sec. Higher Edu. Cess
|
|
0.2
|
INR
|
|
|
|
|
|
|
Total
Bill Amount
|
|
220.6
|
INR
|
Now, the price that the customer pays to “FG Manufacturer Ltd.” is Rs 220.6/-.
And out of this, Rs 20.6/- is the “Excise Tax”.
All apologies for being repetitive, but again, as you can see, this Rs 20.6/-
is collected from the customer by the manufacturing plant. The end customer has
just got to trust that the manufacturing plant pays up this money to the
“Excise Authority.. “.
Whenever such buying of RM and selling of FG happens, it gets recorded as
“transactions” by the accounts department of the manufacturing plant. Here, in
this above example of a purchase of RM and a sale of FG, a total of two
transactions have happened. To simplify things, I’ll assume that these two
transactions are the only transactions that have happened in a duration of 1
month.(assume… )
In this case, the accounts department of the manufacturing plant will have
recorded all the tax related transactions as shown in the tables below:-
Records of “Basic
Excise Duty”:-
|
Basic Excise Duty
|
|
Paid (while purchasing items)
|
|
Received (while selling items)
|
|
Date
|
Item Name
|
Qty
|
Amount
|
Currency
|
|
Date
|
Item Name
|
Qty
|
Amount
|
Currency
|
|
dd/mm/yy
|
RM
|
1
|
10
|
INR
|
|
dd/mm/yy
|
FG
|
1
|
20
|
INR
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Paid Amount
|
10
|
INR
|
|
Total
Recieved Amount
|
20
|
INR
|
Records of “Higher Education Cess”:-
|
Higher Education cess
|
|
Paid (while purchasing items)
|
|
Received (while selling items)
|
|
Date
|
Item Name
|
Qty
|
Amount
|
Currency
|
|
Date
|
Item Name
|
Qty
|
Amount
|
Currency
|
|
dd/mm/yy
|
RM
|
1
|
0.2
|
INR
|
|
dd/mm/yy
|
FG
|
1
|
0.4
|
INR
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Paid Amount
|
0.2
|
INR
|
|
Total
Recieved Amount
|
0.4
|
INR
|
Records of “secondary Higher Education Cess”:-
|
Secondary Higher Education cess
|
|
Paid (while purchasing items)
|
|
Received (while selling items)
|
|
Date
|
Item Name
|
Qty
|
Amount
|
Currency
|
|
Date
|
Item Name
|
Qty
|
Amount
|
Currency
|
|
dd/mm/yy
|
RM
|
1
|
0.1
|
INR
|
|
dd/mm/yy
|
FG
|
1
|
0.2
|
INR
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Paid Amount
|
0.1
|
INR
|
|
Total
Received Amount
|
0.2
|
INR
|
Consider the “Basic Excise Duty” Table:-
Transactions like these keep getting recorded as
and when they take place. At the end of a fixed period, lets say, 1 month, the
manufacturing company has a record of “Total Paid Amount” and “Total Received
Amount” in each category. This is the time when they decide to pay up the money
they’ve collected as “taxes” from their customers.
“Excise Duty” = (Basic Excise Duty) + (Higher Education Cess) +
(Secondary Higher Education Cess);
Now, whatever I’m going to explain from here on is what this article is really
all about. I shall use “Example Scenarios” to explain the concept:-
EXAMPLE SCENARIO 1 :-
If we look at the “Basic Excise Duty” table, the
“Total Received Amount” here is Rs 20/-. The “Total Received Amount” is
essentially the amount received as tax by the manufacturing plant from the
customer whenever they made a sale.
The next activity that the manufacturing company does, at the end of the
month is send a cheque of Rs 20.6/- to the “Excise Authority.. “ . The
amount is Rs 20.6/- since, out of Rs 220.6/- , this amount of Rs 20.6/- was
collected as “Excise Duty” to pay to the “Excise Authority.. “. And so, they’re
sincerely sending a cheque of Rs 20.6/- to the “Excise Authority..” .
But if you notice, there is something wrong with this numerical value of Rs
20.6/-.
What exactly is wrong? Let me explain. According to me, if the manufacturing
plant sends a cheque amount of Rs 20.6/- to the “Excise Authority.. “ , then in
my view, the “Excise Authority.. “ has acted very smart and has actually
collected a total of Rs 30.9/- as “Excise Duty” for this particular product
called “FG”. And Rs 30/- as “Excise Duty” for a product (FG) with
an “assessable cost” of Rs 200/-, essentially makes the “Excise Duty” equal to
15% of the “Assessable Cost”.
Q. What makes me think that “Excise Authority.. “ acted smart and has
actually collected 15% instead of 10% as “Excise Duty”?
Answer: FG contains an item
called RM, and the manufacturing plant has already paid a tax called “Excise
Duty” for this item called RM.
To elaborate, When the manufacturing plant purchased the item called
“RM” for the purpose of manufacturing FG, the manufacturing plant paid Rs
10.3/- there itself as “Excise Duty”. Even though they made the payment to “ABC
Supplier”, they paid it with a belief that Rs 10.3/- out of the Rs 110.3/- will
inturn be paid by “ABC Supplier” as “Excise Duty” to the “Excise Authory.. “.
This form of payment of tax is generally referred to as “Indirect Tax”. Now,
how sincerely “ABC Supplier” goes ahead and pays this Rs 10.3/- to “Excise
Authority.. “ is not really something that the manufacturing plant is
interested in knowing.
There is an error in Example Scenario 1.
EXAMPLE SCENARIO 2:-
At the end of 1 month, the manufacturing plant sends a cheque of Rs
10.3/- to “Excise authority.. “ to clear the total amount remaining to be
paid as “Excise Duty”.
If you see and are able to automatically give the reason why sending Rs
10.3/- as “Excise Duty” to the “Excise Authority.. “ solves this tax problem,
then Congratulations!! J You’ve understood the concept!! J
However, I’ll still go ahead and explain Example Scenario 2.
“If any Finished Good that is manufactured, contains Raw Materials
within it for which excise tax was paid during the purchase of Raw Materials,
then those values of tax paid during the purchase of Raw Materials, can be
subtracted from the total amount received as tax during sale of Finished Goods,
and the value obtained on this subtraction, is the balance excise tax that the
manufacturing plant has got to pay.” ( in my own words and NOT any textbook
definition… )
I’ll admit that the above statement is slightly confusing. I looked at every
possible way to simplify it, but I couldn’t.
So I’ll come back to my FG and RM example to explain the above statement:-
In my above example, the customer who is buying 1 unit of FG is paid a
total of Rs 220.6/- to buy it.
This FG purchased contains 1 unit of RM in it. The Manufacturing Plant paid
a total of Rs 110.3/- to buy 1 unit of RM. When the manufacturing plant paid Rs
110.3/-, they took a bill which clearly stated that a total of Rs 10.3/-
out of Rs 110.3/- was tax. So, the accounts department of the
manufacturing plant concluded that they’ve already paid a tax of Rs 10.3/- . (and yes, they have… indirectly though… ). The accounts
department records it in their books and their computer.
Next, the manufacturing plant sold 1 unit of FG for a price of Rs
220.6/-. While doing this, the manufacturing plant gave a bill stating that Rs
20.6/- out of Rs 220.6/- is tax. So, the accounts department concludes
that they now need to give a total of Rs 20.6/- as tax to concerned
authorities. But then, they’ve already paid a tax of Rs 10.3/- while buying RM.
So, the total amount remaining to be paid as tax, according to them, now is the
value obtained when Rs 10.3/- is subtracted from Rs 20.6/-. That is:-
|
Manufacturing Plant:-
|
|
Sl No.
|
Description
|
Amount
|
|
(1)
|
Tax to
be paid due to sale of FG
|
Rs
20.6/-
|
|
(2)
|
(minus)
Tax already paid during purchase of RM
|
Rs
10.3/-
|
|
(3)
|
Balance Tax to be paid
|
Rs 10.3/-
|
So, now if the manufacturing plant pays Rs 10.3/- to the concerned
authorities, they’re done with paying up all their taxes!! J
And that’s it!!
