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By Siri Bulusu
A pending tax court ruling could stymie foreign companies trying to enter or advance in the Indian marketplace by offering steep discounts on consumer goods—a common practice among e-commerce companies.
Flipkart India Pvt. Ltd., an India-based online retailer, is awaiting a decision from the Bangalore Income Tax Appellate Tribunal on whether losses incurred from discounting are taxable as a capital expenditure or deductible as a revenue expenditure.
The company is currently fighting the $16.8 million tax bill on the grounds that marketing expenses drive sales and should be deductible as a revenue expense.
The tax court decision, expected in the coming weeks, could upend a longstanding principle in Indian tax law that marketing expenses used to drive sales are essential business expenses and are thus deductible from taxable income.
The decision will set a precedent for online and brick-and-mortar companies that offer deep discounts to capture the Indian market—a method used by most foreign multinationals that can afford short-term losses for market share. India’s online retail market, a highly coveted sector, is slated to grow to $80.1 billion by 2022.
The case is creating a “panic” among other e-commerce companies, since discounting is a feature of all e-commerce company business models, Shailesh Kumar, director of direct tax at Nangia & Co., told Bloomberg Tax April 16.
“Discounting expenditures used to be allowed as a revenue expenditure deduction, therefore if the tax demand is upheld it will be a big challenge for e-commerce companies, consumer goods retailers, electronics sellers and luxury brands,” Maulik Doshi, partner and senior executive director at SKP Business Consulting LLP, told Bloomberg Tax April 16.
At an April hearing in Bangalore, Flipkart argued that the 1961 Income Tax Act doesn’t require that products are sold at any particular price—so any revenue earned from discounting products shouldn’t be treated as a capital expenditure, Doshi said.
Revenue authorities said the discounting is motivated by Flipkart’s strategy to capture the Indian market and enhance its brand, which leads to high valuations.
Neither Flipkart nor India’s Central Board of Direct Taxes responded to Bloomberg Tax’s request for comment.
Flipkart is currently valued at around $12 billion, according to various media reports, and is considering selling a controlling stake to either Walmart Inc. or Amazon.com Inc. in the coming weeks.
The e-commerce company currently holds 35.7 percent of India’s online retail market.
In March 2017, the company reported $3.7 billion in losses, nearly doubling its losses from the previous year—an indication of how hard the company has had to lean on discounts to compete against other e-commerce companies like Amazon and Snapdeal.
“Essentially, if you look at Indian consumer patterns, they’re more comfortable to purchase products they’ve seen and felt—so to shift consumer patterns from physical to online there has to be a significant price incentive,” Doshi said.
Because the sector is so new, there is no precedent for taxing the type of expenditures e-commerce companies are incurring, practitioners said, adding to the high-stakes outcome of the Flipkart decision.
Indian tax law has traditionally 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.
Indian tax authorities claimed that Flipkart was deducting expenses that were related to building and promoting their brand, according to court documents, and made an original tax adjustment of $213.6 million to the company’s taxable income from assessment year 2015-16.
Upon appeal by Flipkart, the commissioner of income-tax appeals upheld the taxable nature of the expenses but reduced the adjustment for assessment year 2015-16 to $203 million, which gave rise to the $16.8 million tax bill, according to the court document.
“Flipkart is alleging that it needs to incur these expenses on a day-to-day basis because, if they don’t, they will lose out on their market share to other companies,” Kumar, from Nangia & Co., said.
Kumar said because e-commerce features newer businesses, the companies “aren’t bothered about profitability” and are instead focused on creating valuation and market share, which could lead to up to 10 years of losses.
“The tax department is saying if companies are incurring such losses on marketing and discounts, they’ve created brand value in the market,” Kumar said, adding that it’s outside the tax office’s purview to recharacterize such expenses just because the amounts are so high.
To contact the reporter on this story: Siri Bulusu in New Delhi at email@example.com
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