When discounts are taxed
Treating discounts as capital expenditure may increase tax liability on start-ups and lead to rise in litigation
Treating discounts as capital expenditure may increase tax liability on start-ups and lead to a rise in litigation. SUDIPTO DEY &
ALNOOR PEERMOHAMED write
It seems e-commerce players and income tax authorities are 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 deducted from the sales revenue for computing taxable profits. As ecommerce 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.
Singh says the deductibility of discounts provided is tested under Section 37(1) of the Act. Under this section, 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 a 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.