Discounts are applied after tax is calculated, but taxes are not calculated based on regular retail price. They're calculated based on the price you sell the item for. What the company does for those discounts is calculate internally the price that with tax factored in would result in a discount of x dollars, and give you that price. Or to put it another way, they calculate regular price + tax, subtract discount, then calculate a price internally that with tax added would give you that discount. So:

Item costs $10.00
Tax amount is 5%, or $0.50
Total is $10.50
Discount is $1.00
New price you pay is $9.50
INTERNAL price for the item is $9.05, with $0.45 tax.

Any other way of doing things wouldn't work.