“EXCISE TAX” and “INDIA LOCALIZATION in Oracle” – A simpler explanation and What they're all about...

“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!! J This is the fundamental concept used in Excise related taxes. All the practical rules are more-or-less works around this fundamental concept.

If you’re one of those who recently got overwhelmed by terms like “RG23”, “PLA”, “tax settlement”, etc and are yet to get to know all about those, then please do not worry. I will be writing about them pretty soon... J

Hope you enjoyed reading!! Have a nice day!! J