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Customer Tax and Discount Rules

Even though I’ve been working with Magento for some years now, the combination of discount rules and tax rules has always been some kind of mathematical mystery. In basic, there are 2 parameters:

  • Apply customer tax before or after the discount.
  • Apply discount rules on prices on prices including or excluding tax.

The combination of these parameters has always been of some interesting results, but whenever the client asked me ‘why?’, I had the break my brain once more on what it all exactly meant.
So that’s why I decided to spent some time examining these rules and their combinations, analyzing the results and in the end, I came up with this article.

The Examples

Basicly there are 4 combinations possible:

  1. Apply Customer Tax before discount, and apply discount on prices excluding tax.
  2. Apply Customer Tax before discount, and apply discount on prices including tax.
  3. Apply Customer Tax after discount, and apply discount on prices excluding tax.
  4. Apply Customer Tax after discount, and apply discount on prices including tax.

There are also 2 kind of discounts to consider:

  1. A discount with a fixed amount (10 EURO for example).
  2. A discount with a percentual amount (10% for example).

This together makes room for 8 different combinations / outcomes. So let’s have a look…

Fixed Discount amount

In all these examples, the catalog price is 30 EURO including tax, the discount is 10 EURO and the tax rate is 20%. This means that the catalog price excluding tax is 25 EURO and the tax value is 5 EURO. So: 25.00 excl. 5.00 tax = 30.00 incl. tax.

Apply customer tax before discount

With this setting the customer tax is applied before the discount is applied. So it’s important to know what the customer tax exactly is.

Apply discount on prices including tax

The discount is 10 EURO of our including price, so this means our new price including tax is 20 EURO. The customer tax is applied before the discount is applied, so we need to get the tax of our full price to the order, which is (20% of 25.00) = 5.00 EURO.
Summary:

Although the order total is what the customer would expect, the tax calculation might seem a bit odd: after all, of the order is 20 EURO incl. tax, if you calculate it back the 20% you would expect to pay should be 3.33 EURO (and the order excl. tax should be 16.67 EURO).
The reason for this is that you pay the tax over the full price (30 EURO), not the discounted price. I’m not sure why you would want this (perhaps there are countries where the tax rules states that discounts may not be taxed?). Otherwise I wouldn’t know why you would ever use this combination.

Apply discount on prices excluding tax

The discount is 10 EURO of our excluding price, so this means our new price excluding tax is 15 EURO. The customer tax is applied before the discount is applied, so we need to get apply the tax of our full price to the order, which is 5.00 EURO:
Summary:

This is funny. Although we have a different setup, we see that the outcome of our numbers is exactly the same. This makes sense, since 10 EURO is 10 EURO, and the tax is in both cases the same since we apply our customer tax before the discount is applied.
So isn’t there any difference? Yes there is, but not for fixed discount. But we’ll get to that later…

Apply customer tax after discount

With this setting the customer tax is applied after the discount is applied. So it’s important to know what the discount exactly is.

Apply discount on prices including tax

The discount is 10 EURO of our including price, so this means our new inclusive price is 20 EURO. The customer tax is applied after the discount is applied, so we need to calculate tax from the full price of the order, which is (30.00 – 10.00) = 20.00 EURO. 20-(20/1.2) = 3.33 So the final tax is 3.33 EURO.
Summary:

This formula adds up and is in 99% the situations what you want:

  • Offer discount on prices inclusive tax.
  • Calculate the tax according to the newly calculated order total.
Apply discount on prices excluding tax

The discount is 10 EURO of our excluding price, so this means our new exclusive price is 20 EURO. Once again, 10 EURO is 10 EURO, so with fixed amounts of discount it doesn’t really matter if it’s applied on the inclusive or exclusive price. The result will once again be the same:
Summary:

In the next part – Percentaul Discount amount – we’ll dive deeper into the differences between these 2 options, while for now their outcome might look the same to you.

Percentual Discount amount

In all these examples, the catalog price is 30 EURO including tax, the discount is 10% and the tax rate is 20%. This means that the catalog price excluding tax is 25 EURO and the tax value is 5 EURO. So: 25.00 excl. 5.00 tax, 30.00 incl. tax.

Apply customer tax before discount

With this setting the customer tax is applied before the discount is applied. So it’s important to know what the customer tax exactly is.

Apply discount on prices including tax

The discount is 10% of our including price, so this means 10% of 30 EURO. Our discount is 3 EURO. The customer tax is applied before the discount is applied, so we need to get the tax of our full price to the order, which is (20% of 25.00) = 5.00 EURO.
Summary:

Although the order total is what the customer would expect, the tax calculation might seem a bit odd: after all, of the order is 27 EURO incl. tax, if you calculate it back the 20% you would expect to pay should be 4.5 EURO (and the order excl. tax should be 22.50 EURO).
The reason for this is that you pay the tax over the full price (30 EURO), not the discounted price.

Apply discount on prices excluding tax

The discount is 10% of our excluding price, so this means 10% of 25 EURO. Our discount is 2.5 EURO. The customer tax is applied before the discount is applied, so we need to get apply the tax of our full price to the order, which is 5.00 EURO:
Summary:

This is most likely not the order total the customer would expect, because the discount is calculated from the price excluding tax. Also, if you calculate back, the 20% discount you would expect would not be 5 EURO but rather 4.83 EURO (which would make the price excl. tax 22.92 EURO).
In my opinion, this combination makes absolutely no sense:

  • If you’re a B2C site, and you communicate your prices and discounts including tax, the customer would expect a discount of 3.00, not 2.50.
  • If you’re a B2B site, and you communicate your prices and discounts excluding tax, the customer would expect an order total of 27.00 (4.50 tax, not 5.00) instead of 27.50.

I would not know in what situation you want have to use this combination.

Apply customer tax after discount

With this setting the customer tax is applied after the discount is applied. So it’s important to know what the discount exactly is.

Apply discount on prices including tax

The discount is 10% of our including price, so this means 10% of 30 EURO. Our discount is 3 EURO. The customer tax is applied after the discount is applied, so we need to calculate tax from the full price of the order, which is (30.00 – 3.00) = 27.00 EURO. 27-(27/1.2) = 4.5. So the final tax is 4.50 EURO.
Summary:

This formula adds up and is in 99% the situations what you want:

  • Offer discount on prices inclusive tax.
  • Calculate the tax according to the newly calculated order total.
Apply discount on prices excluding tax

The discount is 10% of our excluding price, so this means 10% of 25 EURO. Our discount is 2.50 EURO. However, this is where it gets weird: because the customer tax is applied
after the discount, we need to subtract the discount of the inclusive price first, and then recalculate the tax.
Summary:

The outcome of this formula might be weird to the customer. If he expects 10% discount of the price included tax, he expects 3 EURO discount, not 2.50. For the rest the calculation adds up:
27.50 / 1.20 = 22.92, and 27.50 - 22.92 = 4.58.

In Conclusion

When it comes to fixed discount, the ‘Apply discount on prices including / excluding tax’ didn’t seem to make a difference in the calculation. Only the ‘Apply Tax before / after discount’ seemed to make a difference, although the whole ‘calculating tax before discount’ resulted in ‘weird’ tax rates.
However… when it comes to percentual discount, we did see where the differences came in to play. As a result of this test, we can conclude that the only logical combination you would likely want to have is ‘Apply Tax after discount / apply discount on prices including tax’. This is the only setting that produces to proper expectations a customer would have, no matter if you’re communicating your prices including or excluding tax.
Giving these results you might wonder: ‘Why all these settings when there is only one possible correct solution?’. That’s a very good question. And I have to say that I don’t know the answer to that one. I’m not sure why you would want any of the other combinations of settings; perhaps there are countries where the tax rules states that discounts may not be taxed?. Otherwise I wouldn’t know why you would ever any of those other combinations.
So… when in doubt: always use ‘Apply Tax after discount / apply discount on prices including tax’, and otherwise you’d better be well aware of what you’re doing. And oh yeah: share with us your use case on why you need a different setting.

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