Explained: How is advertising expense taxed?

Now that a lot of startups take the online advertising route, it is important to understand how is advertising expense taxed. Read on.
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[Editorial Notes: Now that a lot of startups take the online advertising route, it is important to understand how is advertising expense taxed. Read on.]

Introducing Capital and Revenue Expenditure

In a recent decision, the income tax tribunal held that advertising expense was a “capital expenditure” since it brought an enduring benefit to the Company.

Just by way of an introduction, let us look at what “capital expenditure” and “revenue expenditure” are:

“Capital expenditure” is expenditure on capital assets, like buildings, machinery, training facilities for employees etc. It brings an “enduring benefit” to the Company.

“Revenue expenditure” on the other hand is expenditure that is incurred for recurring activities, like salaries, repair and maintenance.

So where does advertising fall?

The tribunal held that advertising was “capital expenditure” because it brought enduring benefit to the Company. However, the High Court of Delhi held, in the decision in CIT v. Monto Motors that the expenditure was a revenue expenditure and not a capital expenditure for the company.

Is the decision correct?

Yes, absolutely. There is no doubt that expenditure in advertising does not yield enduring returns in the same way that a machine might. Public memory today is so short that despite bringing in the biggest stars and investing hundreds of crores, large companies quickly vanish from the public memory when the going gets tough and they are unable to promote their products aggressively.

What does it mean for entrepreneurs?

In the case of Monto Motors, a now beleaguered moped manufacturer, the expenses on advertising were close to Rs. 1.5 crores. Such a heavy investment, if treated as a capital expenditure, can only be written off by means of depreciation.

On the other hand, revenue expenditure can be written off in the same year, while computing taxable income. So treating large expenditure as revenue expenditure would definitely be beneficial to the entrepreneur.

However, you have to make sure that the expenditure is incurred in that calendar year. If the expenditure pertains to some other calendar year, it will not be allowed as expenditure for that year.

What expenditure would fall under the category of “advertising expenditure”

This is tricky one. It depends on the business you are doing. For instance, if your business is a web based business or SaaS business, then the advertising would predominantly be online on LinkedIn, Facebook or Google. If you have advertised on any of these places, you will get a online receipt proving that you have spent the money on advertising.

If you are advertising in offline media, like books, magazines and newspapers, it is much more clear-cut and the expenditure can be straightaway written off as advertising expense.

What if you promote an event, or put up a stall at a fest? Here, you will be selling your product or service, and additionally, creating awareness about your product. In our opinion, that would count as marketing and advertising expenditure too.

What if the stall was a permanent / long term stall – say a 3 year contract to have your stall? That would probably fall under the category of capital expenditure + revenue expenditure. The expenditure incurred in setting up the stall would be treated as capital expenditure while the cost of manpower to man the stall as well as the brochures, banners and other printed material would be treated as revenue expenditure, since it is an advertising cost.

[About the author: Contributed by Hrishikesh Datar, founder of vakilsearch.com, online legal services provider (Legal Advice, Legal Documents & more.]

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Also see: E-Commerce Startups: Here is what you need to know about VAT and Service Tax liability

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