It seems e-commerce players and income tax authorities are out playing a cat and mouse game. The bone of contention is the discounts offered by e-commerce players.
Businesses – both online and offline – treat discounts as revenue expenditure. Such expenses are then reduced from the sales revenue for computing taxable profits. As e-commerce players offer a large volume of discounts to stir and retain demand for their products and services, the tax department has now taken a position that such expenses should be treated as capital expenditure.
It will be, however, difficult for tax authorities to prove in courts that such discounts will stand the test of being a capital expenditure, say legal experts.
“The tax laws do not specifically prescribe any treatment in respect of discounts offered by offline/ online retailers in the normal course of their business,” says Amarjeet Singh, partner and north India, tax head at KPMG in India. Section 30 to 36 of the Income-tax Act, 1961, provides the details of expenses that can be claimed as a deduction against business income. However, discounts are not specifically covered under those sections.
Opening the pandora’s box
What is the contention of the income-tax authority
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Discounts being offered by e-commerce players are more in nature of customer acquisition costs and thus provide enduring benefit
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The purpose is to acquire market share for future profitability
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Discounts being offered in most instances are more than gross margins of the companies on the underlying products
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They are also part of brand building exercise, which is supported by the growing brand valuation of such companies and thus lead to creation of marketing intangibles
How do e-commerce players counter these claims
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Offering an discount is a business decision
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The deductibility of discounts provided are tested under Section 37(1) of the I-T Act
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While the purpose of the expense may be customer attraction and retention, they do not lead to creation of assets
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Discounts provided may not stand the test of being a capital expenditure as laid down by numerous judicial precedents
Singh says the deductibility of discounts provided is tested under Section 37(1) of the Act. Under this section, for any expenditure to be deducted against the business income has to be incurred exclusively for the purpose of the business of a taxpayer. Further, that expenditure must not be of a capital/personal nature.
So far, the tax department has accepted that position and accepted treatment of such discounts as part of the business expense. The recent change in position by the tax department has not gone down well with most tax experts.
“Giving a customer discount on a particular product is a business decision. The tax authorities are nobody to step into the shoes of the businessman to decide what expenses are reasonable to be incurred for conducting its business,” says Rakesh Nangia, managing partner, Nangia & Co.
What makes e-commerce players nervous is that if the department’s new position is accepted by higher appellate authorities and the courts, it will have wider tax and business implications for the start-up ecosystem. The contention of the tax department is that such discounts should be capitalised as ‘intangible assets’ in the tax books. Alternatively, such an amount should be deferred and allowed to a taxpayer over a period of up to 10 years.
“This will lead to increased profits as per the income tax computation of these start-ups and higher tax outflow in the initial years which will hurt their cash flow,” says Amit Maheshwari, partner, Ashok Maheshwary & Associates.
Tax experts point out that courts have held in many cases that expense incurred in a year for business should be allowed as a deduction in the same year itself. “Prima facie, the stand of the tax authorities does not seem to be correct,” says Sanjay Sanghvi, partner, Khaitan & Co.
Maheshwari says if the position of the tax department is accepted, this will certainly lead to an increase in litigation.
Most legal experts agree that it may not be easy for the tax department to prove in courts that such discounts are capital in nature. “If you go by jurisprudence, there have been many judgements that say that taxation is not governed by the accounting but by the substance of the transaction,” says a tax expert and lawyer who advises several start-ups.
For the tax department it is going to be very difficult to prove their position as they may not be privy to internal records of a business, he says. “The courts only go by the evidence that is provided,” he adds.
Sanghvi agrees it is unlikely that the position adopted by the department is going to pass muster at higher appellate fora. “While the purpose of the expense may be customer attraction and retention, it must be noted that no asset is created,” he says. Singh points out that discounts provided may not stand the test of being a capital expenditure as laid down by numerous judicial precedents.
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