Bengaluru, January 22, 2018

The move could mean that many startups would have major tax liabilities as the money they spend on marketing activities will no longer be considered a cost to the company

Consumer technology startups that spend a lot of money on buying customers through discounts and advertising could be in for a rude shock as the Income Tax department could ask them to begin classifying their marketing expenses as capital expenditure.

The move could mean that many startups would have major tax liabilities as the money they spend on marketing activities will no longer be considered a cost to the company. Right now, most consumer tech startups report this expenditure under marketing expenses that are deducted from their revenues, causing them to post losses.

The Economic Times first reported on Monday that Flipkart had lost an appeal against the IT department over the reclassification of marketing expenses and discounting as capital expenditure. The report stated that the IT department's move could affect all large e-commerce firms in the country as well as startups.

"It's a significant liability. If the tax department's stance is taken, essentially marketing and discounting is an investment that goes into building a business and is not an operational cost. If this happens it is quite likely that e-commerce companies would begin to show some form of profits on their bottom line," said Devangshu Dutta, Chief Executive at Third Eyesight.

While the extent of tax liabilities will depend on how much a company is spending on marketing and discounting, firms which are operationally profitable could be taxed. Dutta says that in the case of large e-commerce firms such as Flipkart and Amazon, the amount spent on marketing could be between 40 to 60 percent of their revenues.

Flipkart's main argument against marketing expenditure and discounts being classified as capital expenditure has been that there is no enduring benefit from the money they are spending. For instance, money spent on television advertising does not have any enduring benefits for Flipkart, making it a revenue expenditure and not capital expenditure.

"It's going to get hard to differentiate between whether an expenditure made by the company is an enduring expenditure or not. It has to withstand the scrutiny of the court as well in the coming days, but this is going to be a significant issue," said a legal expert from a reputed law firm who did not want to be named.

He added that if the IT department initiates such a kind of litigation it will have a marked implication on the industry as a whole and not just e-commerce giants such as Flipkart. The major contention of the hearing in the court will be to define what are the attributes of an expenditure to be classified as capital expenditure.

[The Business Standard]