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Ecommerce player Flipkart has lost an appeal against the Income Tax (IT) department over the reclassification of marketing expenditure and discounts as capital expenditure, which involves substantial tax liabilities.

As per the ruling in December, the IT department wants ecommerce companies to reclassify discounts as not a cost but a capital expenditure, meaning that it should not be deducted from revenue.

The issue involves money spent by ecommerce companies on marketing through deep discounts. Flipkart along with Amazon India and other ecommerce companies have been classifying this as marketing expenses and deducting it from revenue, leading to them posting losses and therefore not being liable to tax.

The Bengaluru IT office had asked Amazon and Flipkart to reclassify marketing expenditure as capital expenditure. Both of them had approached the Commissioner of Income Tax (Appeals), Bengaluru, in August last year. Last month, the CIT (Appeals) hearing Flipkart’s case ruled in favour of IT department and said the company must reclassify its discounts and marketing expenses as capex.

As per the IT department, capital expenditure has to be spread over four to 10 years.

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If the ruling goes through, companies such as Flipkart and Amazon India that incur substantial marketing costs could be deemed as being profitable and therefore liable to pay 30% tax. A senior executive at the company confirmed the development and told ET that it’s looking to challenge the order at the Income Tax Appellate Tribunal (ITAT) in the next few days.

An email sent to Flipkart awaited a response at the time of publication.

Capital expenditure versus revenue expense is an old thorny issue for the tax department The IT department believes that discounts and large marketing costs are a part of the brand-building exercise. As per an official close to the development,

“These discounts along with huge marketing and advertising expenses are creating market intangibles for the company. This means these are not costs but capital for the company.”

Both Flipkart and Amazon pumped in a huge amount of money to provide attractive discounts on festive season sales last year. As per a RedSeer report, the cash burn in the industry during the September-October 2017 sale days was estimated to reach $370-400 Mn up from $200-250 Mn last year, on a gross GMV of $1.05 Bn.

While the tax department is yet to say how much the ecommerce would like Flipkart and Amazon would be liable for, the ruling could impact the way startups are taxed in the country.

The IT department’s move to ask ecommerce giant Flipkart to reclassify discounts as marketing expenditure is yet another case of how the department seems to be dictating how startups and entrepreneurs should conduct their business. Same as in line with its recent tough stance on Angel tax. Startups are getting harassed by Income tax officials for raising capital, threatening to consider it as income, which led to a number of Indian startups and members of the startup community coming forward to start an online petition, seeking a revision of the angel tax structure.

[The development was reported by ET]

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