Tax effect of Indirect sale distribution channels

CA Maneet Pal Pasricha

(www.capasricha.com)

In fast growing economies like India, china etc.; Global companies are looking forward to pioneer there products to have there share of pie. While introducing products in new markets, one of the major decisions which companies needs to take is to identify the marketing strategy along with the superlative distribution channel for its products. Company has to select the distribution channel from among the various options like distribution through agents (indirect channels), exclusive distribution, intensive distribution etc. The most common and successful channel is indirect channel, Depending on the industry, between 30 percent and 70 percent of all sales worldwide flow through indirect channels, allowing businesses to lower costs, expand more aggressively into new markets and better serve existing customers and reach new ones. In India such distribution model is relied upon by many companies across the sectors like consumer durables, telecommunication, airline companies etc.

But not always indirect distribution channels can be tax effective. According to Income-tax Act, 1961 “the Act” companies need to withhold tax under section 194H on amount of commission paid to its distributors/ agents or anyone else. Generally the companies selling goods through agents sell its product to agents at price less than market price, Now here arise the point of legal action, whether difference between the retail price (at which product is sold to end user) and the price at which product is transferred to agents is “discount” or “commission”. Income-tax authorities consider it to be commission to try cover such transactions under the ambit of section 194H and on the other hand companies consider it to be a discount. In recent times there flowed numerous judgements from various forums dealing on this issue, some against and some in favour of the assessee. Some of the facts on which these cases were decided are principal-agent relationship, Control of company on agents in respect of operations and price of the products, type of agreement etc. It in essence depends on the facts of the cases and technical assessment of these facts. Wrong interpretation can attract huge interest, penalties and disallowance; under section 201(1A), 271C and 40(ia) of the act respectively, of commissions expenses. Such provisions can have severe cash impact on companies, suppose the company has paid commission of INR 100,000 and has not withheld tax on such amount, then such default can lead to cumulative cash outflow of INR 52,000 in terms of interest, penalties and additional loss of tax saving on disallowed expenditure. In addition to this company will also be declared as assessee in default and may further attract the interest and penalty under section 220 and 221 of the act. Thereby giving hit of more than 52% of expense amount in addition to the expense.

In order to avoid lethal effects of Withholding Tax Provisions companies should take experts views for determining the possible effects of tax provisions of major business decisions like putting its distribution channels in place etc.