THE JOINT COMMISSIONER OF INCOME TAX SPECIAL RANGE-3 , BANGALORE vs. M/S FLIPKART INDIA PRIVATE LIMITED , BANGALORE

The Assessee is a company. During the relevant previous years relevant to AYs 2012-13 to 2014-15, it was engaged in the business of wholesale trader/distributor of books, mobiles, computers and related accessories. It filed a return of income for AYs 2012-13, 2013-14 & 2014-15 declaring loss of Rs.107,35,11,463, Rs.270,39,22,480/- and Rs.358,81,84,343/- respectively.

On the above submission the AO observed that the volume of sales of the Assessee was Rs.199.75 Crores in AY 2012-13 and increased to Rs.9351.75 Crores in AY 2015-16. He 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 cannot be accepted.

The AO examined the Senior Vice-President and Finance Controller of the Flipkart Group Sri.Rajnish Baweja, by issuing summons to him by virtue of his power to summon witness u/s.131 of the Income Tax Act, 1961 (Act). The sum and substance of the statement of the Vice-President according to the AO was that the strategy of selling at a price lower (predatory pricing) than the cost price is to capture market share and to earn profits in the long run. According to the AO the benefit to the online buyer in the short run in the form of lower price is to create indirect benefit to the Assessee in the long run.

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 in this regard referred to the fact that the Assessee during the previous year relevant to AY 2015-16 sold its shares at a huge premium (Equity shares of face value of Re.1/- was sold at a premium of Rs.18,999/- per equity shares) based on the valuation of those shares under the Discounted Cash Flow method (DCF Method). The DCF Method estimates the cash flows in future and uses appropriate discounting factors to arrive at the current enterprise value. This was one reason for the AO to conclude that the strategy of incurring loss in the present was to reap benefit of such loss in future by capturing E-Commerce market.

The AO thereafter concluded that the losses incurred by the Assessee was to create marketing intangibles 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%.

The AO called upon the Assessee to explain why the difference between higher purchases and lower sales should not be inferred as a pricing strategy leading to enduring benefits; and hence leading to generation of capital asset. The Assessee replied that no part of purchases by an enterprise carrying on trading business can be considered as capital expenditure. The Assessee submitted that expenses incurred does not create any asset of an enduring advantage.

The AO held that the business of the Assessee is different from traditional way of understanding the business. He was of the view that in traditional business if an enterprise incurs loss no investor will come forward to invest in such business but in spite of huge losses international expert investors are investing in capital at high premium with the Assessee. Hence the entire way of viewing this new business has to have a different approach in accounting and taxing principles. The Assessee contended before the AO that selling at a price below cost price does not lead to generation of any “identifiable asset”. The AO however held that intangible assets are assets without physical presence and the fact that the Assessee followed predatory pricing in order to create marketing intangibles and brand. According to him the enhanced valuations at which venture capitalists invest in the Assessee is not valuation of any tangible asset or profitability, but that valuation is mostly based on intangibles generated by Assessee. Hence, selling at a price below prices is not an irrational economic behavior. It is a clearly thought strategy to establish a monopoly in market by brand building by generating consumer goodwill. This strategy naturally leads to generation of intangible assets and enduring benefits that assessee has failed to acknowledge and recognize.

The AO thereafter embarked upon method of valuation of intangibles. The first observation of the AO was that E-commerce business does not follow the traditional methods for earning income and hence assessment of income in the case of E-commerce business also cannot be done by following traditional methods. The AO referred to three approaches of valuation of intangibles prescribed by OECD in its convention of Base Erosion and Profit Shifting (BEPS) viz., cost approach, income approach and market approach. The AO adopted cost approach in which a reasonable profit margin is attributed to the cost of purchases and to the extent the profit is foregone by the Assessee was to be considered as the value of intangible.

For the above purpose there was a need to find out average gross margin on cost for other wholesalers in the market. The AO took the database for wholesalers dealing in consumer and electronic goods. He took the average profit margins of companies engaged in wholesale business in consumer electronic goods and compared the said profit margin with Assessee’s profit margin of loss.

On the basis of the above, the AO arrived at an addition to the total income for AY 2012-13 to 2014-15, as follows:-

Aggrieved by the order of the AO, the Assessee preferred appeal before CIT(A). The CIT(A) noticed that on identical addition made in AY 2015-16, the ITAT Bangalore Bench in Assessee’s own case reported in [2018] 92 taxmann.com 387 (Bangalore - Trib.) Fliipkart India (P.) Ltd. Vs. Assistant Commissioner of Income-tax, Circle-3 (1) (1), Bangalore IT APPEAL NOS. 202 & 693 (BANG.) OF 2018 for ASSESSMENT YEAR 2015-16 order dated APRIL 25, 2018 deleted the addition made by the revenue authorities holding that where a trader transfers his goods to another trader at a price less than market price and transaction is a bona fide one, taxing authority cannot take into account market price of those goods, ignoring real price fetched to ascertain profit from transaction. The Tribunal further held that even otherwise, since assessee had not incurred any expenditure to acquire marketing intangibles or for creation of goodwill, the order passed by Assessing Officer was not sustainable. Following the aforesaid order of the Tribunal, the CIT(A) deleted the addition made by the AO.

Aggrieved by the orders of the CIT(A), the Revenue has preferred the present appeals before the Tribunal. The grounds of appeal in AY 2012-13 reads thus:-

The grounds of appeal for AY 2013-14 & 2014-15 are identical but these grounds are slightly different from AY 2012-13. The grounds of appeal for AY 2013-14, reads thus:-

The Attention of the ITAT was not drawn to the fact that the Assessee and the Retailer WS Retail Pvt. Ltd were associated and controlled by the Assessee company itself wherein earlier and during current AY 2013-14, the founders of Flipkart were the Directors of the Company and thereby deciding the operations of the WS Retail Pvt Ltd.

The factual aspect that Assessee as a wholesaler supplied majority of the total goods sold on its portal Flipkart to its own retail arm WS Retail Pvt Ltd as mentioned in the Order as well is bound to have an effect on the judgement of the Tribunal on which reliance has been placed once the matter is highlighted before the Tribunal.

The terms of the Agreement between the Assessee and the Retailer, WS Retail bringing forth the fact that the transaction between Assessee and the WS Retail was not an independent transaction as the supply agreement and license and service agreement between the parties, prohibits / controls the WS Retail either to purchase / procure goods from any person other than the Assessee and also to sell the said goods other than, to the customers placing orders in the Flipkart portal, would only lead to analogy that entire transaction is an colorable device to claim the cost of creating intangible asset as business loss and the same is bound to have an effect on the judgement of the Tribunal on which reliance has been placed once the matter is highlighted before the Tribunal.

We have given a careful consideration to the rival submissions. On identical addition made in AY 2015-16, this Tribunal held that the starting point for computing income from business is the profit or loss as per the profit and loss account of the Assessee, which cannot be disregarded unless certain provisions [Section 145(3)] of the IT Act are invoked. Since the AO has not invoked such provisions, the AO is not empowered to go beyond the book results. It was held that it is settled law that “where a trader transfers his goods to another trader at a price less than the market price and the transaction is a bonafide one, the taxing authority cannot take into account the market price of those goods, ignoring the real price fetched to ascertain the profit from the transaction” and “income which has accrued or arisen can only be subject matter of total income and not income which could have been earned but not earned”. It was held that “the AO was not right in proceeding to ignore the books results of the Assessee and resorting to a process of estimating total income of the Assessee in the manner in which he did, what can be taxed is only income that accrues or arises as laid down in Sec.5 of the Act. Nothing beyond Sec.5 of the Act can be brought to tax”. It was held that there is no provision to disregard the loss declared by the Assessee and also there is no provision by which the Revenue can ignore the sale price declared by an Assessee and proceed to enhance the sale price without any material before him to show that the Assessee has in fact realized higher sale price. In fact, whenever, the Legislature intended to tax income not earned, they have made a provision to this effect. It was held that there was no expenditure which was incurred by the Assessee and one cannot proceed on the basis of a presumption that profit forgone is expenditure incurred and further that expenditure incurred was for acquiring intangible assets like brand, goodwill etc. It was also held the valuation of intangibles is academic since it rejected the basic position adopted by the Revenue and held that the Assessing Officer should accept the loss declared by the Assessee. The Tribunal concluded that the action of the Revenue in disregarding the books results cannot be sustained and the further conclusion that the action of the Revenue in presuming that the Assessee had incurred expenditure for creating intangible assets/brand or goodwill is without any basis. Accordingly, the loss declared by the Assessee in the return of income should be accepted by the AO and the action of disallowing the expenses in without any basis.

We are of the view that the aforesaid conclusion of the Tribunal will equally apply to AY 2012-13 to 2014-15 also as the basis of making the addition in these AYs are also the same as it was made in AY 2015-16. The allegation of the revenue regarding the Assessee and M/S.WS Retail Pvt.Ltd., being related parties does not emanate from the order of assessment. The revenue cannot be permitted to take a stand which was not the factual basis on which addition was made by the AO. Even otherwise, there is no basis for the stand taken by the revenue in the grounds of appeal. We therefore find no merit in these appeals by the revenue. Respectfully following the order of the Tribunal in Assessee’s own case for AY 2015-16, we uphold the orders of the CIT(A) and dismiss, these appeals by the revenue.

In the result, appeals by the revenue are dismissed.