The line of demarcation between capital and revenue expenditure is very thin and the ultimate conclusion on the nature of the expenditure is always a question of law and fact. There are numerous case laws widening line between these expenses. As the Act does not define the terms, one has to depend on their natural meaning on case to case basis.
Recently, the case law of Flipkart has created strife in the e-commerce industry and investors. However, on appeal, it was decided in favour of Flipkart by Income Tax Appellate Tribunal(ITAT). Summary of the case is as follows:
Contention of the Department:
Flipkart reported sales as net of trade discounts which are offered to the
customers. The purchase and sales
figures were for FY 2014-15 as follows:
| Particulars | Amount |
| Purchases | Rs. 10335,73,05,882 |
| Less: Stock Unsold | Rs. 741,83,06,836 |
| Rs. 9593,89,99,046 | |
| Less: Sale value | Rs. 9351,75,05,319 |
| Gross Loss | Rs. 242,14,93,727 |
Flipkart India, despite being a wholesaler selling popular goods, reported losses at the gross-profit level. The company’s motive was to capture market by creating marketing intangibles in terms of customer base, brands and trademarks, which, in turn, resulted in high valuation of business.
During the assessment, department had taken a view that Flipkart received an enduring benefit in the form of edge over competitors and brand building because of aggressive
discounts (cash discounts to the extent of 3% of the turnover) or “predatory pricing”.
Therefore, it embarked upon valuation of intangibles. It took the database for wholesalers dealing in consumer and electronic goods and arrived at the following conclusion –
“The market average of gross profit margin for wholesalers is 16.95%. Had the assessee not followed predatory pricing policy, its average sale price would have been Rs. 9593,89,99,046+ (16.95% of Rs. 9593,89,99,046) i.e. Rs. 11220,06,59,384. Assessee’s real sales is Rs. 9351,75,05,319. The reduction in sales due to following assessee's strategy of selling at a price lower than Cost, the difference of Rs. 1868,31,54,065 between the price at which the assessee is selling and the price the normal wholesaler would have sold is the value of expenses incurred by assessee towards cost of marketing intangibles in the year. Therefore, the amount of Rs. 1868,31,54,065 has to be capitalized and depreciated at the rate of 25%.”
Contention of Flipkart:
Flipkart contended that discounts are the expenses which the company incurs year on year basis to sell its products and retain its market share. Thus, entire amount of such expenses was claimed as revenue expenditure.
Nothing in the Income Tax Act mandates that a product has to be sold at a particular price, and revenue not earned (by virtue of giving discounts) cannot be treated as capital expenditure i.e. tax cannot be charged on fictional / notional income.
Issue under consideration:
Flipkart has never shown profit in past several years but as we can see that the valuation of the Company is increasing. Contention of the department was to tax Flipkart as it is creating its brand by retaining market share.
Department is trying to tax on notional income which here is increase in valuation. It views Flipkart as an anomaly since the company has been making losses while its valuation has been on the rise.
If the seller sells a product worth Rs.2000 and earns a profit of Rs.20 on it, Flipkart spends Rs.40-50 to advertise the product and build the brand.
Currently, companies report sales figures as net of trade discounts. Plant and Machinery, server cost, patent and other such expenses are capitalised in the books. If valuation methods as explained above are adopted by the department and value of marketing intangibles are capitalised, e-commerce companies like Flipkart, Amazon which generally reports losses will turn profitable. Thus, would be liable to pay taxes.
Industry experts say a verdict against Flipkart by higher appellate authorities could fundamentally change how E-Commerce Industry in India is taxed.
Treating discounts given by e-commerce companies 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.
Note: This article is for educational purpose only.