Discussion on the justification of taxing ad expense by govt

SANJEEV, THANKS FOR THE RESPONSE.

U HIGHLIGHTED THE FACT THAT THERE IS NO ISSUE OF DOUBLE TAXATION BUT RATHER AN ISSUE WERE TAX IS COLLECTED ON THE SAME REVENUE STREAM TWICE.

I DO AGREE COMPLETELY. WOULD IT BE ALL RIGHT FOR U TO TELL ME, ANOTHER SITUATION BARRING DIVIDENDS AND CAPITAL GAINS TAX, HOLDS TRUE FOR UR ARGUEMENT.? 

SEE, WHAT I TRIED TO TELL IS THAT IF WE CONSIDER THE STRICTER MEANING OF DOUBLE TAXATION THEN MY DOUBT WOULDN'T APPLY, AS HERE TWO DIFFERENT ASSSESEES ARE PAYING TAX ON THE SAME REVENUE STREAM FOR THE GOVT. BUT IF U CONSIDER IT IN A MUCH BROADER SENSE, DON'T U FEEL THAT THE GOVT'S CHEATING OUT ON U........

AND MY SECOND ARGUMENT IS THAT ON UR INSISTENCE THAT, THERE EXISTS TWO PAYMENTS. AND TWO PAYMENTS REGARDLESS OF THE SINGLE REVENUE STREAM ATTRACTS TAX AND IS COMPLETELY JUSTIFIABLE. BUT IS IT???

CONSIDER THIS: EXAMPLE:  CONSIDER A SERVICE BUSINESS( X ) WITH A REVENUE OF 1 CRORE AND ITS ONLY EXPENSE IS THE 10 LACKS GIVEN TO AN EMPLYOYEE. 

Here there exists two payments. One: being the revenue of the Firm "X"( As this revenue is an expense of another Firm),,,,,,,, two: the expense to the employee as salary. If ur argument is correct, this firm would pay tax on 1 crore and the employee again pays tax on 10 Lakhs. But this never happens instead the firm pays tax on only 90 Lakhs and the employee pays tax on 10 lakhs. THUS A SINGLE REVENUE STREAM OF 1 CRORE, FROM THE POINT OF GOVT, IS TAXED ONLY ONCE. NOT TWICE. HAD IT BEEN TAXED TWICE, THEN THE FIRM AND THE EMPLOYEE PAYS TAX ON Rs. 10 LAKHS TWICE. BUT THIS DOESN'T HAPPEN.

As per as my logic: For advertising agency Rs 10 cr will include service tax. The car mfg co will claim input of S.T paid by it.

The advertising agency will not pay tax on 10 cr but claim certain amt as deduction for expenses.

The balance amt will be subject to direct taxation.

The mfg unit will claim deduction of 10 cr as expense and thus pay tax only on profit.

The customer is charged vat on car purchased and it is indirect tax.

Since there are two different types of taxes: direct and indirect, it won’t amount to double taxation

Vat is charged only on goods and not services, so it can be argued to charge vat on amt excluding advertisements but advertisement is service received by  mfg unit and not by customer and thus it is addition in amt of value received by customer. If advertisement expenses are to be excluded then even salary and labor charges will have to be ignored as it will lead to double taxation from your point of view

IF that is done, it won’t be possible to get exact profits and taxes of mgf co.

Hope this is useful to you.

Sneha ........nicely explained. Keep it up!!!

@ saurabh tx :)

Good point, Ms Sneha.  It should also be remembered that merely because somebody is incurring some expense, it does not mean they have earned a profit.  A loss making unit also incurs expenditure on essential items like rent, electricity, wages, salary etc.  How can we conclude that this is a 'revenue stream' and tax has already been paid on this amount? 

Simply put, the income is charged to tax at the point it arises to every person and this is the simplest and fairest method of taxation.  As far as dividend distribution tax is concerned, the company pays taxes twice on the same income, once as corporate tax and again as dividend distribution tax.  This is why the recipients of dividend are exempt from tax, since the company pays the taxes on dividend on their behalf.

Sneha- would like to discuss more on thie logic u hav raised.

Logic 1: Manf Firm doesn't pay tax, as this is a deductable expense. The Ad Agency pays tax , say 30% or so( yes after its deductions) and end consumer of the product to which this AD cost has been allocated to, pays VAT @ 5/13%.......

See from the govt's point of view, its taking the 30% tax on 10crore, and considering if all items are sold, the Govt gets again the VAT amount too, which the consumers collectively pay. 

My question is, considering the Revenue Stream being the same, for the GOVT, IS IT ETHICALLY RIGHT?

The only conclusion I get is that the revenue the GOVT generates, goes to different pockets, i.e STATE & CENTRAL..... regardless of the name the mode of revenue generated by GOVT be - DIRECT or INDIRECT. So in the broader sense of DOUBLE TAXATION definition, its DOUBLE TAXATION ITSELF. The Govt does tax the same revenue stream at two different points. Is this an Equitable Legislation?

LOGIC 2: Yes, if Customer doesn't have to pay VAT on the Ad cost added along to the product, then it would be arguable that other services that the Manf Firm receives are to be avoided too. 

My argument is: Lets walk through the consequence of such a provision. The firm incuring a huge Advertisement cost passes on this cost to the end consumer even when the real benefit of the AD is for the MANF firm( MORE REVENUE @ CONSUMERS COST) than the Consumer. This doesn't create any incentive for the company to go for more effective and efficient mode of Advertisement that reduces such cost to the end consumer. Unlike Advertisement cost, salary and wages payments are against services rendered that has a reflection on the product, that the end consumer gets in terms of quality and craftsmanshiop. It could be argued that since consumer receives such value addition, paying tax on it, is justifiable( barring the double taxation issue raised earlier).

What if ???? if the manf firm has to incur this ADvertising expense out of its Profit after tax/ Retained Earnings alone, which means AD expense being a non deductable expense, the firm would be paying tax on an equivalent amount( yes at a higher % and double taxation applies) and that unit cost of each product cannot include the Ad cost. This would create an environment were companies would give more thought into its huge AD expense with the same effort it puts forward for dividend payouts.

Isn't this better.???  But only if, issue of double taxation doesn't exist, as per Sneha's first argument and its justifiable to tax the manf.

Originally posted by : Member
	Good point, Ms Sneha.  It should also be remembered that merely because somebody is incurring some expense, it does not mean they have earned a profit.  A loss making unit also incurs expenditure on essential items like rent, electricity, wages, salary etc.  How can we conclude that this is a 'revenue stream' and tax has already been paid on this amount?    Simply put, the income is charged to tax at the point it arises to every person and this is the simplest and fairest method of taxation.  As far as dividend distribution tax is concerned, the company pays taxes twice on the same income, once as corporate tax and again as dividend distribution tax.  This is why the recipients of dividend are exempt from tax, since the company pays the taxes on dividend on their behalf.

Para 1: I don't think i ever said that, i guess, u might have missed the point.

Para2:  Thus double taxation exist as Company pays tax twice on the same income.

No point considering advertisement separately since on every product there are two sources of income for government and it is not always necessary that person pays both direct n indirect taxes for ex: tax holidays ,basic exemption granted by Govt.It would be impossible or very costly for Govt to trace person paying Dt n not charge IDT on him. The both are sources for govt and has to be paid by common man.If u take advtsmnt to retained earnings,it will reduce shareholders wealth which would again effect common man.

@ Jose

It is true that the advertisement cost is loaded on the end consumer buyer indirect way, but it does not means that without advertisement the cost would go lower, its the company policy to use the funds in advertisements or so called business promotion activities, by whatsoever manner they like to.

advertisements are deducted from the profit of the car manufacturer, so the question of taxability at car manufacturrer point does not arise. though they are slapped with service tax/vat/CST/WCT ....................out of which most are eligible for input credit by the car manufacturer ( subject ot apended negative list )

now come to advertising agency ..................

its a pure business of advertising agency, where they receive 10CR in gross, and ofcourse the company has not sent the amount as gift to them, .....................the advertisement agency has to incur expenses on providing advertisement on behalf of company and pay for the services tendered, the balance of amount is taxed under the hands of advertisement agency @ slab rates ( may be 30% max rate at this point), apart from this they have to pay ........................... profession tax, service tax, vat, establishment cost etc. 

now coming to the final end buyers point

they have brought a car "without any advertisement cost imposed", you can see their invoices for this reference, company does not charge any penny extra on account of advertisement, so they have to pay the cost of CAR only, irrespective of fact that the advertisement cost is indirectly added in the cost of car, but not only the cost of advertisement cost, there are other costs also realized from the end buyer, viz dealer / distributor share of amount , transporation of car from factory to showroom,  showroom upkeep costs, amc charges provided by dealer under warrantee period, .....................all such costs are loaded on cost of car at par with advertisement cost for which eligible persons have to charge and pay taxes on their own. 

its the marketing system adopted by companies , which may differ one from other, but such costs can not be segregated for each unit product, suppose the company paid 10cr and incurred loss at the end of year, so who is sufferer of such payout? obviously the company coz he is the owner of the descision for paying such advertisement,  govt has nothing to interfare about it but to claim their tax.

hope the doubts are getting clear.

Advertisemnt exps r part of operating expenses and hence cannot be excluded.No co. will incurr very huge advmnt exps dat due to it,the cost of product rises and  competitor takes advantage of it

Note::::oh sorry, just realised there is actually a second page to this thread, but anyway this reply is for sneha for the second reply posted 2 days ago. and Sharma Sir, I shall give u a reply soon. thank u guys for the post. Anyway,

Sneha,

Consider this eg:

Firm A has a turnover of Rs 100 Crore by selling 10 generators/ transformers. The expenses it incurs are Salary-50,00,000, Transportation-50,00,000, Advertisement- 10,00,00,000. 

According to what u say:

Here, each transformer costs Rs 10 crore each and the salary, transportation and advertisement when apportioned to each transformer, would have contributed to the Sale price by Rs 5 Lak, Rs 5lak and Rs 1 crore respectively. Its justifiable for the consumer to incur the cost of salary and transportation as the product would have better product quality and products being delivered within the best time and WITH least damages( IF ANY). But unlike the other two cost, Advertisement would have helped the sale of 5/ 10 transformers. i.e the firm through spending Rs 10 Crore on Ads, got in a revenue of Rs 50 crores and as per your arguement, the consumer took up the cost of this ad expense of Rs 10 crore and also paid a proportionate tax on it( via VAT, as the product's gross cost reflects this value too). 

The financial effect of this: 

Firm: increased its revenue when the consumer paid for the Ads. 

Govt: charged Direct tax on Ad agency receiving the income of Rs 10crore and collected Indirect tax from consumers, while they paid for the product( product cost does inclue the Ad cost, as per ur arguement).

Consumer: paid the indirect tax on the AD cost which actually benefitted the firm more than the consumer.

Conclusion: So as per ur arguement, 1: its alrit for the firm to have spent Rs 10 crore on ads and passed on that cost towards consumers. It did pay Rs 10 crore to the Ad agency and in effect took back that expense from consumers and in the meantime gained 5 times the amount in revenues. Even if the company pays tax on the increased revenue( Rs 50 crores) it still benefited about Rs 35 crores or so, after tax. 2: Its alrit for the Govt  to have got its share of income from taxing the Ad Agency( direct Tax) and from consumers ( indirect Tax), i.e taxed the same revenue stream twice, regardless of the names to the mode of collection- direct & indirect. 3:  its also alrit,  that the consumer paid tax on a cost that actually benefited the Firm dis-proportionately more.

Example: Thus its alright for hospitals to have charged patients more on the justification of Ad cost that they incur. Its alright for Pharmaceuticals to spent huge amounts on Ads and Commissions to doctors and to re cliam the amount from consumers. in need of the medicine. Its also alright for the colleges and schools to charge higher fees in the name of Ad cost incured.

Benefits of a rule that makes it possible to stop passing on Ad cost to consumers, but ask firms to pay it out from their retained earning:

Firms: for firms, they will have to incur it out of their retained earnings and as this is an allocation of the portion of profit, a good corporate governance structure would require disclosures pertaining to the huge Advertisement spending made by these firms. Imagine what it would be like for firms, like Vodafone and Airtel, has to justify on its inefficient huge ad expenditure on its products. In effect the corporates would think twice or thrice and give more importance to the ad expense decisions as disclosures need to be there.

Consumer: For consumers, they get a better price for the products.

Govt: For Govt, Issue of double taxation is avoided as the only time it taxes, would be on Ad agency's income. Consumers doesn't pay any indirect tax via VAT on product's gross value,as its illegal for companys to hav added advertisement expense along with the product cost.

Yes, economic reality would be that product pricing due to market pressures wouldn't include Advertisement costs, then why isn't the Accounting principles, taxing policy and corporate governance requirements reflect the same? If things are as per ur arguement, I stress on the fact that consumers are being duped by Govt( when it collects tax twice on same revenue stream), by Firms( while gaining revenue at consumers cost).

Sharma Sir,

I shall highlight certain points that u made.

1:It is true that the advertisement cost is loaded on the end consumer buyer indirect way::::  Indirectely by inflating other costs??

2:advertisements are deducted from the profit of the car manufacturer, so the question of taxability at car manufacturrer point does not arise. ::: True, as the Revenue gets reduced to the extend of Ad expense.

3:its a pure business of advertising agency, where they receive 10CR in gross,,,,,, and agency has to incur expenses on providing advertisement on behalf of company ,,,,, the balance of amount is taxed under the hands of advertisement agency @ slab rates.::: I Completely agree with u Sir.

4:they have brought a car "without any advertisement cost imposed", you can see their invoices for this reference, company does not charge any penny extra on account of advertisement, so they have to pay the cost of CAR only, irrespective of fact that the advertisement cost is indirectly added in the cost of car, but not only the cost of advertisement cost, there are other costs also realized from the end buyer, viz dealer / distributor share of amount , transporation of car from factory to showroom,  showroom upkeep costs, amc charges provided by dealer under warrantee period, .....................all such costs are loaded on cost of car at par with advertisement cost for which eligible persons have to charge and pay taxes on their own. :::: Sir am an audit assistant at a local firm, have seen clients creation of invoices for their expenses, Lets suppose their exists a law that says AD exp to be borne out of retained earnings and not chargeable to customer,,, If so, is it possible for a large company to inflate other costs without proper supportings as they would hav a stronger disclosure requirements..... or am I being too naive??

5::: its the marketing system adopted by companies , which may differ one from other, but such costs can not be segregated for each unit product, suppose the company paid 10cr and incurred loss at the end of year, so who is sufferer of such payout? obviously the company coz he is the owner of the descision for paying such advertisement, :::: I agree, economic reality would not allow product pricing to include ad exp considering there exists a good competitiv environment??? But can anyone say that its not happening, when every company in the Industry does add the cost of Ads indirectly to their products?? And what about Pharmaceutical companys???? does an equally good generic drug sold by the Govt in its outlets, prevent its privatised and advertised version frm charging a higher price?, as the pvt firms behave like a cartel,,, so is cement??

6: govt has nothing to interfare about it but to claim their tax:::  would there be a differanc if there exists a law that says AD expense has to be borne out of retaned earnings and customers cannot be indirectly charged too(( Is tat practical??))) and if there are strong Disclosure requirements on how Ad exp, would it deter Companys from overcharging consumers??? Govt still can tax th govt if its from retained earnings( as its P.A.T) and supposing all the above said rules exists and works effectively, consumers would not be paying any tax( like VAT) on those expenses, right??

Sir, still I do have a doubt,,, considering Accounting and product pricing be different,,, how can the Company that has a Head of Accounts named "Advertisement Expense" choose to indirectly inflate the cost of other Expense heads that reflects on the final Sales price of the product(( am stressing on costs that reflects on the product, not as per accounts, as all costs, as per accounts, need not be added along with th product))??? If so, doesn't the company evade tax twice over this as this is an allowable expense....??? Would all this problem vanish if a law as mentioned above exists and the supporting structures makes sure the same.......

@ Jose

if we look the mercantile system of accounting at a glance, there are two principal parts of P/L account, 1) manufacturing and trading account and 2nd, profit and loss account.

whereas the car got produced at manufacturing and trading account itself, where advertisement cost does not exist ( other indirect expenses also)

in nutshell the manufacturing and trading accounts reflects only the direct expenses incurred towards production of car, and nothing is deducted from gross profit except the direct expenses of materials and labour / workshop rent/ electricity which is essential part to manufacture a car ( or without which the car can not be made) and the resultant is gross profit. 

now coming to Profit and loss account , where gross profit is credit and debit is ................blah blah, interest to bank, commission, ADVERTISEMENT, business pomotion, telephone, fax, travelling and what not ........................but even without these the car could be manufactured, ( taking depriciation as a diff note, coz its not a cash deduction but accounting method only)

so if the govt has to take a note of what you have suggested, then they have to allow all these P/L account expenses from tax paid income and tax the gross profit ( less depriciation only), and then allow the company to pay the expenses from the retained profit...................is not it ?

as you have said that you are involved in accounts audit, just imagine the scenerio, 

also the car sale price is fixed as per market demand and supply, there is no way to reduce it by cutting the expense on advt, if they dont advertise, they will spend it on other perks, end buyer will not get any benefit unless all car dealers agree to reduce the sale price. 

time to time govt slaps diff modes of levy and taxes on companies to curb excess use of profit towards many of heads, FBT was such a measure to avoid excess allocation towards expenses. 

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with gradually developing tax reforms and we wish after imposition of GST and DTC in short time, we shall be able to get more effective way of costing and we expect that the companies policy would be restricted to certain extent not to overload the end users with their royal and luxary expenses.