The tax department had contended that the loss in the form of discounts offered to customers is intended to build up brand value/monopoly or primacy in the online market.
"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 etc," said the Bangalore bench of the ITAT in its order dated April 25.
The company had pleaded before the ITAT that since e-commerce was in its nascent stage, it was very difficult to create trust and awareness of sale through this mode. "The volume of sales was very low. One of the ways to increase volume of sales and attract buyers to e-commerce was to offer discounted prices," it said.
However, the I-T department said it should be treated as 'capital expenditure' since it helped in creating 'brand value' and 'marketing intangibles' for Flipkart.
The ITAT in its order said "we hold that the loss as declared by the Assessee in the return of income should be accepted by the AO (assessing officer)..."
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 "is without any basis and not in accordance with law", the ITAT said.
As per the February 6 interim order passed by the ITAT, Flipkart was asked to deposit 50 per cent of the tax demand and and furnish bank guarantee for balance demand for a period of 6 months by February 28, 2018.
Nangia & Co Managing Partner Rakesh Nangia said, "In order to give effect to the ITAT's favourable ruling, the revenue authorities will have to refund the demand already paid by Flipkart. This refund shall come with interest at half a percent per month for each completed month.
"The revenue authorities may choose to file appeal against the ITAT order before the High Court, but that shall not in anyway impact the refund of tax demand already paid".
Flipkart was fighting its case with the income tax department regarding tax treatment of substantial expenditure incurred by it in the nature of product discounts, advertisement and marketing expenses.
In its tax return, Flipkart had claimed that it needs to incur such expenses on a year-on-year basis to sell its products and retain its market share, thus entire amount of such expenses is deductible as tax expense.
On the other side, the income tax department treated such expenditure as 'capital expenditure', claiming that such expenses created 'brand value' and 'marketing intangibles' for Flipkart and thus entire amount of such expenses was 'not deductible' as tax expense and has to be capitalised.
This ruling is very important from the perspective that product discounting, advertisement and marketing expenses constitute a major portion of expenses of e-commerce companies, which such e-commerce companies incur on day to day basis, Nangia said.
"This is an essential feature of e-commerce business model, primarily dealing with consumer products and selling directly to end consumers. This, being the first favourable ruling from the tax tribunal on this litigative matter, would certainly give a relief to the e-commerce companies across the country incurring similar expenditure," he added.