APRIL 02, 2018

By Subhashree R

UNLIKE a person selling price inelastic goods like essentials or luxuries, most sellers have to adopt the price which will culminate in demand - defined in economics as the intersection of need, ability and willingness to pay the price. Thus, price wars, sales promotion by showing value addition, offers, etc., are the norms in most businesses that rely on volumes to maximise returns. Of course, the tax department is never enamoured of a sale at price which does not seem to be the normal price for a person seeking to earn profits. We have seen innumerable disputes in excise and customs valuation, and in anti-dumping investigations. Income tax laws also have their fair share of provisions (for e.g. Section 50C) to determine what should be the right price or value.

Quantum of discount - Can it determine classification?

The characterization of deep discounts offered by e-commerce companies has been in news recently. Revenue authorities seem to have taken a view that these discounts are to be treated as capital expenditure because they are aimed at brand building and increasing market share, entailing benefits of an enduring nature. The revenue authorities' argument is that the discounts create intangibles and the expenditure on such discount cannot be allowed as a deduction in one go as revenue expenditure.

It is quite elementary that different business will adopt different strategies and there cannot be a uniform mark-up that a business or class of businesses could be expected to earn, though transfer pricing provisions try to convince us otherwise. The e-commerce model - be it inventory model, market-place model or aggregator model - is characterized by variety of choice, competitive pricing and quick delivery in order to attract the maximum customers.

The elusive litmus test

There is no single test to determine whether an expenditure is capital or revenue and the determination depends on facts and circumstances, intention of parties, nature of transaction and so on. While a number of tests may be applied based on judicial precedents and accounting principles, no single test is decisive. Some of the commonly used tests are:-

- The enduring benefit test - If the business derives benefits over a longer period of time, the expenditure can be said to be capital in nature.

- Test of nexus with profit-earning process vs. changes to profit-earning apparatus - If the expenditure enables continuance of business and is related to the carrying on of the business rather than the framework of the business, it can be said to be revenue expenditure.

- Test of whether expenditure is incurred one time or is recurring in nature.

- Test whether the expenditure leads to creation of a capital asset or is part of day-to-day operations of the business.

However the treatment of an item of expenditure will also depend on facts and circumstances. For instance, while expenses relating to issue of share capital are generally not accepted as revenue expenditure, in CIT v. Glaxo Laboratories, [1990] 50 Taxman 219(Bombay), the High Court held that keeping in view the object of the issue which was to obtain government approval for continuance of a technical collaboration agreement, the expenditure would be revenue in nature.

E-Commerce - Discounts not attractive to Revenue

In the context of e-commerce entities, the ability to offer the most attractive prices to the customer definitely plays an important role in profit-earning process. It is not a case of penetration price which may be adopted by certain entities to enter the market and then increase prices to profitable levels. Similar to certain industries like infrastructure or iron and steel with long gestation periods, e-commerce entities have to necessarily incur expenditure on competitive pricing.

The revenue authorities' argument is that the discounts contribute to creation of intangibles like enhancing brand value which helps the entity to increase market share, gain customer loyalty and so on. It is difficult to accept the argument that discounts given by the entity would result in enduring benefits from brand value.

Even assuming that offering discounts aid in promoting sales of goods and enable the entity to garner greater market share, it can hardly be said that the benefits of discount offered spill over to a number of years and create intangible assets. Offer of discount is not a one-time exercise which will yield benefits over years. In any case, in Empire Jute - 2002-TIOL-238-SC-IT-LB, it was held that not every benefit of enduring nature can be said to be capital in nature. In a recent case, ACIT v. Jansons Industries Ltd, ITA 613 -615/Mds/2017 decided on 8.2.2018, ITAT, Chennai followed Empire Jute and held that a mere incidental benefit or enduring benefit or commercial advantage cannot result in disallowing the claim of the assessee. In this case, the assessee incurred advertisement expenses, recorded as brand promotion expenses in respect of goods sold by it. The assessee was also paying royalty for use of the brand. The revenue authorities claimed that the expenses resulted in promotion of the trademark/brand and hence the expenditure was capital in nature. However, the ITAT rejected the argument of the revenue authorities and allowed the expenditure as revenue.

The expenditure on discounts is part of the profit-earning process. Physical retailers as well as well as online sellers have to necessarily extend discounts as off-season sales, festival offers, etc. This holds good for even for premium products, for instance, cars in luxury segment. Discounts can serve as aid for sales promotion which is generally a short-term exercise as compared to say expenditure on positioning of a product as a cheap alternative to competing goods.

Trailing law - Testing times for new businesses

Law often does not keep pace with a dynamic business environment, new business models, technological advancements, etc. This is evident from the attempts of tax authorities world over to effectively tax online transactions or deal with digital presence of an entity in a country. In the context of e-commerce, it must be said that discounts are part of the normal business operations. The mode of carrying on business, day to day operations cannot be said to be capital in nature. Whether the benefits of these deep discounts are enduring or not, the pains caused by tax disputes arising out of it definitely are.

[The author is Advocate, Direct Tax Practice, Lakshmi kumaran & Sridharan, New Delhi and the views expressed are strictly personal.]