E-Retailers Win as India Scraps Flipkart’s $16.4 Million Tax Demand (2)

Trust Bloomberg Tax's Premier International Tax offering for the news and guidance to navigate the complex tax treaty networks and business regulations.

By Siri Bulusu

An Indian court passed a ruling that allows Flipkart to deduct all marketing and promotional expenses from its taxable income—an outcome that will drastically reduce the e-commerce giant’s tax bill.

The Bangalore Income Tax Appellate Tribunal on April 24 struck down the Indian tax authority’s claim that marketing and promotional expenses incurred by Flipkart India Pvt. Ltd. added to its brand value and should therefore be classified as capital expenditure.

The ruling spares Flipkart from a $16.4 million tax demand.

The ruling was highly anticipated, as the outcome impacts all companies vying for a slice of India’s booming online retail market. It is a major win for e-commerce companies like Flipkart and Amazon.com Inc., which use heavy discounts and promotional offers to up sales, practitioners told Bloomberg Tax.

Flipkart and Amazon.com didn’t respond to Bloomberg Tax’s request for comment. Court documents aren’t yet publicly available.

“This ruling is very important from the perspective that, product discounting, advertisement, and marketing expenses constitute a major portion of expenses of e-commerce companies, which they incur on day to day basis,” Rakesh Nangia, managing partner at Nangia & Co. LLP, said April 25.

Characterizing Expenses

Indian tax law has deemed brand promotional expenses to be revenue expenses because they generate sales essential to business operations. Capital expenditures, such as asset purchases, are strategic and add to the long-term value of the company and are therefore taxable, practitioners said.

“E-commerce companies have to use these promotional methods in order to capture the attention of Indian consumers — it is not up to the tax officer to step into the businessman’s shoes and determine how to characterize the expenses,” Nangia said.

Indian tax authorities claimed that Flipkart was deducting expenses that were related to building and promoting their brand, and ultimately contributing to its overall valuation, according to court documents. The assessing officer made an original tax adjustment of $209.4 million to the company’s taxable income from assessment year 2015-16.

Upon appeal by Flipkart, the commissioner of income-tax appeals upheld that the expenses were taxable but reduced the adjustment for assessment year 2015-16 to $199 million, which gave rise to the $16.4 million tax bill, according to the court document.

“It is very common practice for the tax department to recharacterize advertising, marketing, and promotional expenses and we’ve seen many cases go through the tax courts arguing this tax principle,” Nangia said.

Practitioners said that even though the principles being debated are common in tax courts, the tax department lacks precedent when it comes to e-commerce companies like Flipkart and Amazon because the industry is still growing.

“The matter could still be taken appealed by the tax department, so we’ll have to see if the tax department agrees with the ITAT’s decision,” Nangia said.

‘Lacking Precedent’

Practitioners said that even though the principles being debated are common in tax courts, the tax department lacks precedent when it comes to e-commerce companies like Flipkart and Amazon because the industry is still burgeoning in India.

“The principles being debated are actually quite clear. Companies need to sustain and retain their normal levels of revenue and that leads to day-to-day expenses, and in the case of e-commerce that means daily discounts,” Rohit Kapur, managing director at Dezan Shira & Associates, said April 25.

Kapur said tax officers were “misguided” when making their additions to Flipkart’s income because the same transfer pricing principles that apply to brick-and-mortar retailers should apply to e-commerce companies, even if matters like start-up valuation make things more complicated. Flipkart is currently valued at about $12 billion—and rising, according to various media reports.

“Anything any company does is in the nature of creating and maintaining brand value, so just because it is a huge amount that is happening online doesn’t give tax officers the right to step in and demand tax,” Kapur said.

Since marketing expenses and company value go hand-in-hand, tax officers could revive the demand in an appeal before a higher court, practitioners said.

“Tax officers should leave it but given the pressure coming from the revenue department they could test the limits of the jurisprudence on the matter,” Kapur said.

To contact the reporter on this story: Siri Bulusu in New Delhi at correspondents@bloomberglaw.com

To contact the editor on this story: Penny Sukhraj at psukhraj@bloombergtax.com

Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.

Request International Tax