Overview:
It has been reported that e-commerce giant Flipkart (“Tax Payer”) has lost an appeal against Income-tax department (“Tax Authority”) for issue regarding classification of marketing expenditure and discounts. The First appellate authority (Commissioner of Income-tax) opined that such marketing expenditure and deep discounts cannot be treated as revenue expenditure as it was incurred to build brand value of the Company and thus, should be re-classified as capital expenditure.
As per media report Tax Authority is of the view that apart from influencing customer behavior, such high spending by e-commerce operators results in improving the goodwill and thereby creating intangible asset for the Company, and hence, should be reclassified as capital expenditure.
In light of the above we have deliberated on some of the key issues related to the topic.
1. Discounts or freebees to customer:
In common parlance discounts is the price reduced from the par value of the product at the time of sale. It is common practice of business to offer discounts on the face value of the products in order to attract customers.
Mainly there are two types of discount viz. trade discount – offered at the time of sale and cash discounts – offered as incentive for fulfilling certain criteria after sales.
Trade Discounts:
Generally, discount offered to the customer are determined at the time of sales and thus, revenue is recognized net of such discounts allowed in the books of accounts as per generally accepted accounting principles.
Determination of price at which goods / services are to be sold is purely a business decision. Except in limited circumstances such as related party transaction, Tax Authority cannot question the sale price of the product or profit margin earned by the tax payer due to lack of any provision in Tax Laws. This view is supported by plethora of judicial precedents according to which Tax Authorities step into the shoes of business man.
Cash Discounts:
It is very difficult to determine the cash discounts at the time of sale and thus, revenue will be recognized at gross amount and the amount of cash discount will be claimed as an expenditure in the statement of profit and loss.
Cash back given on various sales by e-commerce giants on fulfilling the certain conditions may be treated as cash discounts in the books of accounts.
2. Revenue v/s Capital expenditure:
This question has always presented a difficult problem and continually baffled the courts, because it has not been possible, despite occasional judicial valor, to formulate a test for distinguishing between capital and revenue expenditure which will provide an infallible answer in all situations. Based on the various judicial pronouncements following factors may be tested to arrive at whether same is a capital expenditure:
Whether expenditure is non-recurring in nature?
Whether expenditure increases the future earning capacity of the business?
Whether expenditure has enduring benefit?
Whether expenditure creates any capital asset?
3. Marketing and Advertisement Expenses:
According to provisions of the Income-tax Act, 1961 any expenditure not being in the nature of capital expenditure or personnel expenses of the assesse expended wholly and exclusively for the purpose of the business or profession shall be deducted while computing the income chargeable to tax under the head “Profits and gains of business or profession”. And thus, any marketing or advertisement expenditure in the nature of revenue expenditure would generally be allowed as an expenditure.
Based on the various judicial pronouncements, it may be said that advertisement and marketing expenditures are recurring expenditure in today’s competitive world and it is incurred to retain the existing market share of the business.
If the Tax Authorities is of the opinion that specific marketing costs are in the nature of capital expenditure, one can reasonably argue that the same is an intangible asset and is eligible to claim the depreciation at the prescribed rate [25%] on such Capital Asset.