In the past, taxman reclassified advertisement expenses and in Flipkart case, this was done for discounts on sales.
E-commerce major Flipkart will be feeling a palpable sense of relief now that the Income Tax Appellate Tribunal (ITAT) has rejected the taxman’s claim that a large part of its discounts could not be treated as legitimate business expenses and that, as a result, it owed the taxman Rs 110 crore for FY16 instead of the nil liability it claimed since it had incurred losses in the year; indeed, the same principle would have led to larger demands for FY17 and FY18 and all subsequent years. Flipkart, in fact, had lost the appeal at the Commissioner Income Tax (CIT) Appeals stage and while it has now won, the taxman will appeal the ITAT verdict in higher courts.
Apart from the fact that the case has large implications for any company offering discounts in both the online and offline space, and not just in the retail business, the taxman made matters worse when it said the expenses were akin to capital expenditure on land. Ideally, any capital expenditure is allowed depreciation, so if the taxman said Flipkart’s discounting was capital expenditure, the company would have been allowed to claim depreciation on this over the next 7-8 years—that is, instead of expensing the discounts in the year in which they took place, Flipkart would be able to expense them over the next 7-8 years. But with the taxman saying the capital expenditure was akin to that on land, it meant no depreciation could be claimed on it.
If the taxman could argue, in the Flipkart case that its discounts were really just meant to establish the Flipkart brand—that’s how they were classified as capital expenditure—the same principle could apply to, say, advertising. Indeed, in the case of Sony Ericsson, some years ago, its Indian arm had shown advertisement and marketing promotion (AMP) expenses—as a ratio of sales—of 7.06%. The taxman, however, rejected the comparators given by Sony Ericsson of other firms in similar lines of business—this was part of the many transfer pricing adjustments made by the taxman against Indian arms of MNCs—and, instead, used a 3.35% number; the ‘additional’ spend was added back to Sony Ericsson’s taxable income that year.
In the case of Reebok India, similarly, the AMP-to-sales of 12.33% was rejected by the taxman in favour of a 2.51% number. In all such cases, the taxman argued the higher AMP was, in fact, expenditure being made to promote the foreign brand, and not to increase local sales—in the case of Maruti Suzuki, the transfer pricing order said the ‘extra’ AMP was nothing but expenditure to promote the Suzuki brand in India.
At that point, the Delhi High Court had come down on this while explaining that brand-building was a long-term and complicated exercise and depended upon a product’s quality and reputation—so linking it with AMP is not recommended. The court even said that if the same parameters were ‘applied to Indian companies with reputed brands and substantial AMP expenses, (it) would lead to difficulty and unforeseen tax implications and complications’. The court also ruled that discounts and commissions had to be included as AMP expenses.
Given that such interpretations have large ramifications, and that the taxman has not been deterred by even the Delhi high court’s views, it is time the Central Board of Direct Taxes applied its mind and gave a ruling against disallowing such expenses. Else, tax adventurism will continue.