E-commerce giants such as Flipkart and Amazon have appealed against an income tax order of last year which if implemented would force them to pay tax at a time when they are engaged in a do-or-die battle for market share in India.

The companies approached the Commissioner of Income Tax (Appeals), Bengaluru, last month after an assessment order of last year asked them to reclassify marketing expenditure as capital expenditure.

The issue involves money spent by ecommerce companies on marketing through deep discounts.

These companies, and others in the ecommerce industry, have been classifying it as marketing expense and deducting it from revenue, leading to huge losses.

The income tax department now feels that such expenses can't be classified as marketing costs and should be reclassified as capital expenditure. Hence, these should not be deducted from revenue.

The tax department, in its assessment order, has justified its stance by claiming that marketing costs for ecommerce companies constitute capital expenditure as they are creating intangibles that may aid future revenue.

If the tax department's methodology is followed, ecommerce companies could turn profitable and be liable for tax in India. The assessment orders were passed last year and applied to all ecommerce companies.

Flipkart and Amazon's appeal was heard last month but the CIT (appeals) did not take an immediate decision. Email queries sent to Amazon and Flipkart on Thursday afternoon did not elicit any response.

A detailed questionnaire to the Central Board of Direct Taxes and the revenue secretary remained unanswered.

Experts say the revenue department's stand could open a Pandora's Box for several startups and ecommerce companies as it dictates how entrepreneurs must conduct their businesses.

"What business expenditure to incur and what quantum is the prerogative of the business concerned to decide. The Assessing Officer (of income tax) has no say in dictating terms of business to a taxpayer, as to how to run his business. There are enough judicial decisions supporting this proposition," said Sanjay Sanghvi, partner (tax) at law firm Khaitan & Co.

"Several startups have to incur heavy expenses to promote products or services and stir up demand for their products.

If such tax demands are made, then several startups including ecommerce companies and FMCG companies who are in the B2C space will start facing the heat from the tax department and would end up being embroiled in litigation.

The taxpayers may have to argue that these expenses are incurred every year and are necessary to run the business and create demand for their services, and without such expenses these startups may just fold up," said Amit Maheshwari, partner, Ashok Maheshwary & Associates.

The ecommerce companies fear the tax department may not change its view and that a second assessment order may soon be passed.

"In the ongoing assessment, we felt the tax officers still think that since marketing and advertising expense is a major expense for us, this is creating intangibles. And this is not a revenue expense," said a person with direct knowledge of the matter.

"Currently there is no provision under the tax law under which a company may not be allowed to deduct genuine marketing expense incurred for business purposes from total revenues. The only way the deduction could be limited is to allege that this is not revenue expenditure," said Maheshwari.