Generally company offsets output tax (payable) against input tax (already paid).
Net tax payable = Output tax (payable) – input tax (already paid)
But tax authority can also declare a portion of input tax which cannot be set off against output tax. This portion of input tax which cannot be offset against output tax is knows as non deductible tax.
Deductible input tax ⇒ Input tax which can be offset against output tax
Non deductible input tax⇒ Input tax which cannot be offset against output tax.
Accounting for deductible input tax and non deductible input tax
Deductible input tax is posted in a separate GL account since it needs to be offset against output tax.
Non deductible input tax amount is added back to expense account. Since this portion of tax is not going to be claimed against output tax hence it is treated as increase in cost or expense.
→ Company purchased goods worth 100 with 10% input tax (deductible)
CR Vendor 110
DR Purchase account 100
DR Input tax account 10
→ Company purchased goods worth 100 with 6% input tax (deductible) and 4% input tax (non deductible).
CR Vendor 110
DR Purchase account 104
DR Input tax account 6
Configuration needed to handle deductible and non-deductible tax
In tax procedure, different types of taxes are represented by tax condition types. Each condition type is assigned to an account key.
Account key decides if the tax amount is going to be treated as deductible tax or non deductible tax.
If posting indicator in account key is 2 (separate line item), calculated tax amount is posted to GL account linked to account key.
If posing indicator in account key is 3 (distribute to relevant expense / revenue items), then tax amount calculated is not posted to any GL account separately rather it’s added back to expense or revenue account.