COMMENT - Why e-commerce discounts sound like capex to I-T sleuths

Normally when a company launches a new product or service, it advertises it. Advertisement helps create a brand from which the company can derive benefit over a longer period of time. Thus advertisement and marketing expenditures whose benefits are likely to accrue over an extended period of time are taken onto the balance sheet and amortised over a 10-year period.

On the other hand, the big discount sales announced with much fanfare by a company are for a fixed period. Normally these sales are around a festive season when most people make their purchases.

Since discounts entail taking a hit on the revenue or foregoing profit for the sake of volume and also because they are for a short period of time, discounts are netted off from the revenue of a company in the profit and loss account and charged on the same year the discount sales have taken place.

Now conventional wisdom is being challenged by the IT department: They have asked for reclassification of marketing expenditure and discounts as capital expenditure. This would nudge the companies towards making profits, and therefore paying taxes.

While in a normal business like say, an automobile business, festive discounts are allowed to be charged in the P&L account, in the case of an e-commerce business it is slightly complex. This is what creates the grey area into which the IT department has waded.

Globally, the e-commerce business has prospered mainly on price arbitrage rather than the convenience of shopping. India is no different. The price differential was a key attraction for consumers to purchase from these websites. E-commerce companies were able to sell goods at a cheaper rate as compared to a brick-and-mortar outlet because of lower cost structure and elimination of the middleman.

But as e-commerce picked up and more sites started offering same goods at identical rates, websites started announcing discount sales like the Big Billion day sale. In 2016, sales on this day amounted to $1.05 billion while in 2017, they touched $1.5 billion. Such sales account for a major chunk of the annual sales of e-commerce companies who have used this day’s contribution to boost their market share.

The IT department is of the view that discounts and large marketing costs that goes into hyping these days are a part of the brand-building exercise from which the company derives benefits over a longer period of time.

To some extent what the IT department is saying is true because many consumers hold back on their buying to wait for the discount sale to make their purchases. In other words, there is a brand recall of The Big Billion Day among shoppers.

The e-commerce companies seem to have dug themselves deeper into a hole by announcing a discount sale on every occasion: There is one ongoing currently called ‘The Republic Day Sale’.

Though the IT department may be right in spirit they still have an uphill task to prove it in letter. The case is likely to be sent to the tribunal where the e-commerce companies could come out on top, given the precedents.

Technically speaking, such cases are subjected to what is called the tests of enduring benefits. An expenditure is allowed to be transferred to the balance sheet only if the benefits are enduring in nature.

As if the confusion on the subject was not enough there is a Supreme Court judgment that adds to it. The Supreme Court in the case of Empire Jute Co Ltd vs CIT (1980)124 ITR 1 ruled that there may be cases where the expenditure can be such that there could be an enduring benefit but the expenditure can still be classified as revenue expenditure.

We have surely not heard the last on the subject.