The income-tax department demanded Flipkart to classify its marketing expenses and discounts as capital expenditure and therefore asked the E-commerce giant to pay the sum of Rs 110 crore as tax demand for the financial year 2015-16 due to a reclassification order on how startups are taxed.
However, Flipkart does not look likely to give up Rs 110 crore so easily and are challenging the order by appearing before the Income Tax Appellate Tribunal (ITAT) with the argument that tax cannot be collected from “fictional income”.
Nothing in the IT Act mandates that a product has to be sold at a particular price, and revenue not earned (due to discounts grants) cannot be treated as capital expenditure,
said Senior Advocate of Flipkart, Percy Pardiwala to the tribunal.
The revenue department’s counter argument is that the Indian e-commerce giant benefits from a very high valuation, based on marketing intangibles despite being not generating profits and low fixed-assets base.
Revenue Counsel CH Sundar Rao argued that the Bengaluru-based startup is reporting losses at the gross-profit level and the motive of such a strategy was to capture market shares by creating marketing intangibles in the customer base, brands and trademarks therefore leading to its high valuation.
Flipkart responded to this point by stating that the e-commerce’s strategy is to earn profits in the long run instead and that discounts on brands and trademarks was part of the marketing strategy it is sticking to.
Presently, startups are categorizing discounts and marketing costs as revenue expenses while capital expenditure includes spendings on patent, machinery and building, etc…. If discounts were to be classified as capital expenditure, Flipkart would be virtually making profits and would be required to pay domestic taxes.
For example, the tax department is imposing a Rs 110 crore tax demand on Flipkart as they estimate that the firm generated profits worth 408 crores for the financial year 2015-16 if the discounts were to be classified as capital expenditure. However, while classifying discounts in the revenue expenses category, Flipkart registered losses of Rs 796 crore in that same period.
If the taxation of Flipkart is indeed revised by the Revenue authorities, it could have a direct impact on how every internet startups and other firms are being taxed in India.
“Asking for significant discounts to be treated as capital expenditure because it helps in building the brand, will affect anyone who offers discounts, even infrequently, including offline players. In fact, this can mean that any expense towards brand-building will be capital expenditure,” said Vaibhav Parikh, corporate lawyer at Nishith Desai Associates. “In the past, there were such cases made against some companies over advertisements, but several have been ruled in favour of the company.”
The revenue counsel also took the opportunity to address another issue which is transfer pricing – which means the price at which divisions of a company transact with each other. experts claim that the discounts of Flipkart India also benefited Flipkart Internet, in which the brand and internet platform of Flipkart India were transferred to. “In the absence of any specific provision to counter such seeming transactions, it could be difficult to bring them under the transfer pricing net,” argued Amit Maheshwari, partner at Ashok Maheshwary & Associates LLP.