By TIOL News Service

BANGALORE, APRIL 27, 2018: THE ISSUE BEFORE THE BENCH IS - Whether discount offered on sale made by e-Commerce platform provider is deemed capital expenditure for creating intangibles or goodwill. NO IS THE VERDICT.

Facts of the case

The Assessee-company, engaged in the business of wholesale trader and distributor of books, mobiles, computers and related accessories, had filed return for the relevant AY declaring loss of around Rs.796 cores. However, during the assessment proceedings, the AO noticed that the Assessee was a wholesale dealer and acquired goods from various persons and was immediately selling the goods to retail sellers like M/S.WS Retail Services Pvt.Ltd. and others, who subsequently would sell those goods as sellers on internet platform under the name 'Flipkart.Com'. The AO further noticed that the Assessee had been purchasing goods at say Rs.100/- and selling them to the retailers at Rs.80/-. The purchases during the relevant PY was around Rs.10335 cores and sales was around Rs.9351 cores.

On being asked, the Assessee explained that sale through electronic form (e-commerce) as against the traditional sale through retail outlets had just begun in 2012 and since eITA commerce was in its nascent stage, it was very difficult to create trust and awareness of sale through e-commerce. According to the Assessee, the volume of sales was very low and one of the ways to increase volume of sales and attract buyers to e-commerce was to offer discounted prices. Higher volume of sales will lead to economies of scale. Therefore, on such basis, the AO observed that the volume of sales of the Assessee was Rs.199.75 Crores in AY 2012-13 and had increased to Rs.9351.75 Crores in relevant AY. He further observed that the volume of increase in sales was 45 times over a period of 3 years. He was therefore of the view that the plea of the Assessee that sale at discounted price to retailers was to increase volume of sales could not be accepted.

The AO thereafter concluded that the strategy of selling goods at lower than cost price was to establish customer goodwill and brand value in the long run and reap benefits in the later years. The AO thereafter concluded that the losses incurred by the Assessee was to create marketing intangible assets and therefore the loss to the extent it is created due to predatory pricing should be regarded as capital expenditure incurred by the Assessee and should be disallowed. The AO was however gracious in holding that the value of marketing intangibles should be considered as an asset used for the purpose of business for which the Assessee should be eligible to claim depreciation at 25%.

Aggrieved by the order of the AO, the Assessee preferred appeal before CIT(A). The CIT(A) confirmed the order of the AO. The CIT(A) also withdrew depreciation of 25% on the intangible assets allowed by the AO while computing total income, for the reason that though the Assessee incurred expenses for creating intangible assets but was not owner of the intangible.

the Tribunal held that,

++ there should be income and its receipt or accrual because it is only income which accrues or arises that can be subject matter of total income u/s.5 of the Act. Sec.14 lays down that income for the purpose of computation of total income has to be classified under the following heads of income viz., Salaries, Income from house property, Profits and gains of business or profession, Capital gains and Income from other sources. Sec.28 of the Act lays down various categories of income that shall be chargeable to income-tax under the head "Profits and gains of business or profession". The income of the Assessee in the present case would fall within Sec.28(i) of the Act viz., "the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year". Section 145 of the Act provides how income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" has to be computed and it lays down that such income shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Sub-section (2) of Section 145 provides that the Central Government may notify in the Official Gazette from time to time income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income. Sub-Section (3) of Section 145 provides that Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee, or income has not been computed in accordance with the standards notified under sub-section (2), the Assessing Officer may make an assessment in the manner provided in section 144. It is thus clear from the statutory provisions that the starting point of computing of income from business is the profit or loss as per the profit and loss account of the Assessee. The AO cannot disregard the profit or loss as disclosed in the profit and loss account, unless he invokes the provisions of Sec.145(3) of the Act. In the present case it is not the case of the AO that the provisions of Sec.145(3) of the Act are applicable. In such circumstances, the question is as to whether the AO had power to go beyond the book results. The AO was not empowered under the Act to do so;

++ to say that an expenditure has been incurred by an Assessee there should be either accrual of liability or actual outflow in the form of payment. There was no such accrual of liability or actual outflow in the present case. This fact is also acknowledged by the AO. The AO has however proceeded to draw hold that because the Assessee was purchase at Rs.100 and selling the goods to retailers at Rs.80/- the rationale for incurring loss by a wholesale trader at the gross level was very peculiar. Since such a pricing was done keeping in mind the long run profits of the Assessee which will grow because of the intangible or brand or goodwill which will be generated in the long run. Therefore to the extent profits are foregone by the Assessee, the Assessee can be deemed to have incurred expenditure on creating intangibles or brand or goodwill and such expenditure has to be regarded as capital expenditure and added to the total income of the Assessee. The first presumption of the AO is that the Assessee had incurred expenditure. As rightly contended by the counsel for the Assessee there was no accrual of any liability on account of any expenditure or actual outflow of funds towards expenditure. One cannot proceed on the basis of presumption that the profit foregone is expenditure incurred and further that expenditure so incurred was for acquiring intangible assets like brand, goodwill. It is not possible to say that profits foregone created goodwill or any other intangibles or brand to the Assesssee. The argument of the counsel for the Revenue on the existence of intangibles or brands or goodwill was on the basis of purchase of Assessee's shares at a premium by investors. Despite making losses, the Assessee's shares were purchased by investors at a high premium. In this regard two instances of purchase by venture capitalists of the shares of the Assessee of Re.1/- in the previous years relevant to AY 15-16 and 14-15 at a premium of Rs.1899/- and Rs.595/- respectively was cited by him. According to him such high share premium was justified only because of the asset base created by the Assessee in the form of brand value. This again is an argument without bringing on record any material to substantial that valuation of shares were done only because of value being ascribed to brand or goodwill or any intangibles. The valuation of shares as per the AO was on DCF method and there is no mention in the order of assessment regarding values being ascribed to goodwill or brand or intangibles. There was no expenditure incurred by the Assessee except those that are set out in the profit and loss account. The question of incurring expenditure on creating intangibles does not arise for consideration at all;

++ the action of the AO in disregarding the books results cannot be sustained and the further conclusion that the action of the AO in presuming that the Assessee had incurred expenditure for creating intangible assets or brand or goodwill is without any basis, there is no neccesity to deal with the arguments that even assuming that expenditure was incurred by the Assessee the expenditure for building brand or creating intangible or goodwill is revenue expenditure and allowable as deduction. It is also not necessary for us to go into the question of estimation of quantum of expenditure on creating intangibles, in view of such conclusions. The loss as declared by the Assessee in the return of income should be accepted by the AO and his action in disallowing expenses and arriving at a positive total income by assuming that there was an expenditure of a capital nature incurred by the Assessee in arriving at a loss as declared in the return of income and further disallowing such expenditure and consequently arriving at a positive total income chargeable to tax is without any basis and not in accordance with law and the said manner of determination of total income is hereby deleted.

(See 2018-TIOL-618-ITAT-BANG)