ITAT Rules In Favour Of Flipkart; No Need To Reclassify Discounts As Capex

While the Indian ecommerce giant Flipkart is working out a deal with Walmart, the homegrown major has won a huge battle with the Income Tax Appellate Tribunal (ITAT) rejecting the revenue department’s argument that discounts rolled out by Flipkart should be reclassified as capital expenditure.

After Flipkart lost its appeal against the Income Tax (IT) department over the reclassification of marketing expenditure and discounts as capital expenditure (capex) which involves a $17.2 Mn (INR 110 Cr) tax penalty on Flipkart on behalf of the tax assessed for FY15-16.

According to IT officials, Flipkart generated a profit of $63.52 Mn (INR 408 Cr) for FY15-16, while the company originally reported a loss of $124 Mn (INR 796 Cr) for the said financial year.

Flipkart has been asked by the Income Tax Appellate Tribunal (ITAT) in Bengaluru to deposit $8.5 Mn (INR 55 Cr) as tax and $8.5 Mn (INR 55 Cr) as a bank guarantee by February 28, 2018.

Following this, the company had challenged the IT department’s decision again in April saying that tax cannot be levied on “fictional income”.

“Nothing in the IT Act mandates that a product has to be sold at a particular price and revenue not earned (by virtue of giving discounts) cannot be treated as capital expenditure,” said Percy Pardiwala, a senior advocate representing Flipkart during the hearing.

Capital expenditure versus revenue expense has been a bone of contention between ecommerce companies and the Income Tax department for quite some time now. The issue primarily revolves around the money spent by these firms on marketing through deep discounts.

Flipkart, Amazon India and other ecommerce companies have been classifying these discounts as marketing expenses and deducting the amount from their revenue, thus leading them to post losses. This is, in turn, enabling them to avail tax deductions on the aforementioned expenditure.

Flipkart reported losses of over $1.3 Bn (INR 8,771 Cr) in FY17, which translated to an increase of 68% from the $814 Mn loss it registered in the fiscal before that. As indicated in the financial reports of Flipkart, a five-fold increase in finance costs of $671 Mn (INR 4,308 Cr) contributed to the losses in FY17.

This comes at a time when a group of brick and mortar retailers including Future group and Reliance Retail and ICA have alleged that ecommerce companies like Flipkart and Amazon India are violating the FDI rules by “influencing prices on their platforms and illegally funding abnormal discounts”.

Both Flipkart and Amazon India have given media statements indicating that on their part, they have been fair and have not been flouting the FDI rules in any manner.

At the same time, the government is mulling over an ecommerce policy with Union Minister Suresh Prabhu heading the first meeting of the ecommerce think tank. Reportedly, the Indian ecommerce think tank, with an agenda to speed upon the process of framing a domestic ecommerce policy, may finalise the framework around ecommerce policy in the next six months.

India’s ecommerce industry is expected to touch $200 Bn by 2026, as per a report by Morgan Stanley. The market reached $33 Bn registering a 19.1% growth in 2016-2017, as per Indian government’s Economic Survey 2018.

This is a time when the wind is blowing towards the ecommerce sector. So, when the industry is ripe and the government has recognised the potential of the ecommerce segment and is even mulling a policy framework, Flipkart’s win against the Income Tax department will provide a huge boost to the company.