Conditional Sales Tax in Dynamics 365 Finance and Operations

Alfredo Iorio
1 day ago
7 min read

Conditional sales tax in Dynamics 365 Finance and Operations allows organisations to defer tax liability based on specific criteria from invoice to payment.

Unlike standard sales tax, which applies immediately upon invoice generation, conditional sales tax defers the tax obligation until we receive the customer payment. In this blog post, we will learn what conditional sales tax is and how to configure it in Microsoft Dynamics 365 Finance and Operations.

Introduction to Conditional Sales Tax

Conditional sales tax defers the tax liability until the customer's payment is received. This approach helps businesses comply with regulations where tax authorities mandate that companies report and remit sales tax when actual payment has been collected from customers.

This cash-basis accounting method differs from the accrual accounting most organisations use for financial reporting, creating a timing difference between sales and tax recognition to ensure accurate compliance reporting.

Before looking into the configuration steps, there's a critical terminology clarification that could save you from a costly compliance mistake, especially if you're implementing in the UK or EU.

Conditional Sale in the UK and EU VAT Context - Important Clarification

In the UK and EU, a Conditional Sale refers to a specific legal transaction type, such as hire purchase or instalment agreements, where the buyer gains possession of goods, but legal title remains with the seller until full payment. This is not to be confused with Conditional Sales Tax.

What Conditional Sale Means in UK/EU Law

For VAT purposes, Conditional Sales mean that the tax point is typically at the time of supply or when goods are made available, and the full output VAT must be accounted for and paid upfront on an accrual basis, regardless of when payments are received.

This calculation aligns with standard VAT rules under the EU VAT Directive and UK HMRC guidance, where conditional sales are treated similarly to credit sales, where VAT is due on the full value at the basic tax point.

Only specific schemes like the UK's Cash Accounting Scheme apply to businesses with a turnover below £1.35 million. Still, even then, conditional sales are explicitly excluded and must use accrual accounting.

The focus here is on the nature of the sale contract, not on deferring tax liability.

Conditional Sales Tax in Dynamics 365 F&O

In contrast, Conditional Sales Tax in F&O is a software-specific feature for managing indirect taxes like VAT, GST, or US sales tax, on a cash basis that allows posting the unrealised tax amount to a temporary liability account at invoicing, then transferring it proportionally to the actual tax liability account only as customer payments are received.

The term Unrealised is key here; that's why the same feature in Dynamics 365 Business Central is called Unrealised Sales Tax: https://learn.microsoft.com/en-gb/dynamics365/business-central/finance-setup-unrealized-vat

The term Conditional used in this F&O module means the tax recognition is on payment, not that it's tied to conditional sale contracts.

If you're using F&O in the UK/EU, you'd configure Conditional Sales Tax only for eligible transactions under schemes like Cash Accounting, but not for actual conditional sales, which require standard accrual setup to avoid non-compliance.

If your setup involves specific localisations, consult local tax authorities or a tax advisor, as software features must align with legal requirements rather than override them.

Prerequisites and Navigation

Before beginning the conditional sales tax configuration process, we must verify that users have the appropriate security roles assigned, specifically the Tax Administrator role or equivalent permissions to access sales tax setup forms.

The first configuration task is to enable Conditional Sales tax on the General Ledger parameters.

Figure 1: General ledger > Ledger setup > General ledger parameters

Then, users can create one or more dedicated sales tax groups to handle conditional sales tax.

Step 1: Set Up Sales Tax Groups

Sales tax groups act as containers for individual sales tax codes. They also define when tax obligations are calculated and reported through the settlement period.

When configuring conditional sales tax, the sales tax group must be associated with a settlement period that accommodates the deferred tax recognition pattern, typically using a cash-basis settlement period rather than the standard accrual period.

*Figure 2: Tax > Indirect taxes > Sales tax > Sales tax groups*

To create a new sales tax group for conditional tax scenarios, navigate to Tax > Sales tax > Sales tax groups and select New. Enter a descriptive identifier in the Sales tax group field, using a naming convention that clearly identifies its conditional nature, such as "RT_Cond" for conditional retail taxes, to distinguish it from your standard sales tax clearly.

The next configuration element is the Settlement period field, which determines the reporting calendar and tax recognition timing for all codes within the group.

*Figure 3: Sales tax code page with Settlement period*

This settlement period must align with the regulatory reporting requirements of the applicable tax authority, including the frequency of returns, which is typically monthly, and the specific due dates for filing.

Step 2: Create Sales Tax Codes

Sales tax codes define the specific rates, calculation bases, and tax jurisdictions that apply to individual transactions. For conditional sales tax scenarios, the Calculation Method field within the sales tax code configuration determines whether tax is calculated on the net amount, gross amount, or through other calculation methods that accommodate conditional tax requirements.

To create a new sales tax code, navigate to Tax > Indirect taxes > Sales tax > Sales tax codes and select New. Enter the following information:

Sales tax code: A unique identifier.
Name: A descriptive name.
Settlement period: Select the cash-basis settlement period created for conditional tax reporting.
Ledger posting group: Select the appropriate posting group that defines the accounts assignments.

*Figure 4: Sales tax codes page showing configuration fields*

On the Calculation FastTab, configure the following parameters:

Origin: Select "Percentage of net amount" for most standard conditional tax scenarios, or "Percentage of gross amount" when the tax base includes other taxes
Calculation method: Choose "Line" to calculate tax per transaction line or "Whole amount" to calculate based on the invoice total
Rounding: Configure rounding rules according to the organisation's requirements.

On the Values FastTab, enter the tax rate percentages.

*Figure 5: Sales tax code calculation parameters*

The system supports multiple rate records to accommodate rate changes over time, with each record specifying the applicable date range and corresponding percentage.

You should now see your new sales tax code in the sales tax codes list, with the settlement period and rates configured as specified.

Step 3: Assign to Ledger Posting Groups

Conditional sales tax requires two ledger posting groups with different account assignments:

Ledger Posting Group for unrealised tax

Sales tax payable: Maps to your conditional/unrealised tax liability account. This is where the tax sits when the invoice is posted, but payment hasn't been received. Note that in F&O, the configuration of this posting group uses Sales Tax Payable even if this account will be used for the conditional tax, not the actual tax payable.

Payment Sales Tax Code for realised tax

Sales tax payable: Maps to your final tax liability account. This is where the balance moves when the customer's payment is received. This group will also require the settlement account because it's the final tax liability code used to calculate realised tax and settlement.

Navigate to Tax > Setup > Sales tax > Ledger posting groups to configure both account assignments.

*Figure 6: Ledger posting group ledgers configuration*

The other Ledger Posting Group to configure is the settlement tax code that will be used to record the tax settlement when the payment is registered.

Step 4: Assign to Tax Groups

Once the Sales Tax Code is configured, we need to assign it to a Sales Tax Group, which will link sales transactions to the correct tax code.

Navigate to Tax > Indirect taxes > Sales tax > Sales tax codes and select the conditional tax group created before. Next, on the Setup tab, click Add to insert the new Sales Tax Code.

*Figure 8: Sales Tax Group and code setup*

Lastly, we need to configure the new conditional sales tax code for an Item Sales Tax Group. In most cases, this is a generic group that applies to all items, but it can be a dedicated group only for products and services where conditional sales tax applies.

Navigate to Tax > Indirect taxes > Sales tax > Item sales tax groups.

In the Setup tab, add the conditional sales tax code.

Step 5: Testing on Sales Orders and Invoices

Once the setup is complete, it's time to test a customer's sales and see if the sales tax calculation is correct.

Begin testing by creating a new sales order for a customer assigned to the conditional sales tax group:

Navigate to Sales and marketing > Sales orders > All sales orders
Create a new sales order and add line items with appropriate products or services.
Verify the sales tax group is correctly inherited from the customer record.
Use the Sales tax button on the Sell tab to view the calculated tax amounts.

*Figure 10: Sales order line posting details*

After posting the sales invoice, verify the voucher entries to confirm that tax amounts have posted to the conditional sales tax account rather than the final tax payable account.

Navigate to Voucher transactions from the posted invoice to examine the detailed account postings. The ledger account used for the tax amount is the Conditional Sales Tax we chose when we set up the sales tax code.

Next, apply a payment to the invoice:

Navigate to Accounts receivable > Payments > Customer payment journal.
Create and post a payment that settles the test invoice.
Review the voucher entries to confirm that tax amounts have transferred from the conditional account to the final tax payable account.

*Figure 12: Conditional sales tax reversed by the payment voucher*

The payment posting reverses the conditional sales liability account and transfers the tax to the final liability account.

Summary

Conditional sales tax in Dynamics 365 Finance and Operations enables cash-basis tax accounting, deferring tax liability until customer payment is received. This approach is essential for businesses operating under cash accounting regulations and helps manage cash flow by aligning tax payments with actual cash receipts.

The configuration requires careful setup of sales tax codes, groups, and crucially, two separate ledger posting groups to manage the transition from unrealised to realised tax liability. Proper testing ensures tax amounts flow correctly from conditional accounts at invoicing to final liability accounts at payment.

Critical for UK/EU Implementations: If you're implementing F&O in the UK or EU, do NOT configure conditional sales tax for hire purchase or instalment sale transactions. These require standard accrual VAT accounting. The conditional sales tax feature is only appropriate for businesses eligible for the Cash Accounting Scheme (turnover under £1.35m) and then only for standard credit sales. Always consult a tax advisor to ensure compliance with local regulations.