Talking Point. Casting the tax net wide

It is an undeniable fact that the e-commerce industry has revolutionised retail trade in India, transformed the way businesses operate and led to a paradigm shift from brick-and-mortar stores to websites and mobile apps. This has resulted in the emergence of new business models different from the traditional ones.

The authorities have been looking at ways to tax these evolving business models — a salient example being the recent decision of the Income Tax Appellate Tribunal in relation to the taxability of the discounts provided by an e-commerce company.

Discount as capex

The e-commerce company in question purchases products from unrelated sellersand sells them to retail sellers (that are also unrelated sellers) at discounted prices. These sellers sell the products on the company’s platform. During the years covered in the judgement, the company was incurring losses at a gross-trading-margin level by using this model.

According to the tax officer, this “predatory pricing” strategy followed by the company led to the creation of intangible assets, gained customers’ goodwill and resulted in the creation of brand value in the long run.

Consequently, the extent of the loss due to this kind of pricing was regarded as capital expenditure by the tax officer and was disallowed. The officer also observed that despite such losses, the company’s shares were being sold at a premium, and contended that the high valuation of these shares were on account of the creation of the intangible assets.

The Income Tax Appellate Tribunal rejected the position taken by the officer on the grounds that it was not within the rights of the tax officer to go beyond company books of accounts and enhance the sales price, without substantiating that the price was realised by company.

The Tribunal also rejected the officer’s contention that the company had incurred expenditure on the creation of intangibles, in the absence of any accrual of liability or payment outflow by it in relation to these. It was also of the opinion that creation of intangible assets such as goodwill was infeasible as it is difficult to ascertain their cost of acquisition, alteration, etc. Moreover, the Tribunal rejected the tax officer’s argument that the high valuation was on account of the intangibles (in the absence of any material evidence substantiating this).

Not the last word

In the e-commerce industry, companies frequently sell products at discounted prices to ‘grab’ the market, and this forms a significant part of their business expenditure.

While their strategy may be different from that of traditional retail companies, the objective of sales promotion remains the same — increasing sales and market share. Therefore, the principle of commercial expediency (recognised by various Indian courts) should also be applicable in the case of e-commerce companies when the courts determine whether sales promotion expenses are allowable for tax purposes.

The tribunal’s judgement upholds this principle and gives the e-commerce industry some breathing space. But this is definitely not the last word because it remains to be seen how the honourable courts will react to the issue when it comes up before them on further appeals.

Going forward, with more corporates embracing the digital mode, these new business models are expected to be on the radar of the authorities as they seek to identify, assess and implement different ways of taxing them.

The writers are Director and Manager - Corporate and International Tax, respectively,at PwC India.

COMMENT NOW