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Update: Karnataka chief minister Siddaramaiah has directed the commercial tax department to study the the laws and issues related to e-commerce and recommend necessary changes, reports The Times Of India.

A finance department official told the publication that the issue is not limited to Amazon, but to all e-commerce firms and they should have more clarity on this issue in about a month.

The government has also asked the tax officials to go slow on license cancellation of merchants until there is clarity and necessary changes have been made.

Earlier (Sep 17): The Karnataka government’s tax department has sent notices to third party merchants working with Amazon India, directing them to stop storing their products in Amazon’s Bangalore fulfillment center, reports Mint citing three sources with direct knowledge of the matter.

The report cites two sources to state that the government has sent license cancellation notices to more than 100 third party merchants that primarily sell electronics, apparel, books, toys and other products, thereby stopping Amazon India from selling products through its Bangalore fulfillment center. These apparently include many of the top sellers at Amazon India.

An undisclosed senior tax official has however told The Economic Times that they have sent notices to about 50 merchants selling products on Amazon India’s online marketplace and they will initiate the process of license cancellation after hearing them.

In an emailed statement to Mint, an Amazon India spokesperson has mentioned that it is working with relevant authorities in Karnataka to resolve this issue and avoid closing its local warehousing operations in Karnataka. It pointed out that this issue has emerged because the tax laws “have not kept pace with the new-age online business models that enable a faster, convenient and nationwide access to customers for sellers, especially small and medium businesses, at significantly low costs”.

Amazon’s fulfillment centers not allowed as additional place of business

The issue here seems to be the fact that hundreds of merchants have apparently stated Amazon’s Bangalore fulfillment center as an additional place of business, which according to the tax authorities is not allowed under the current tax laws.

Note that Amazon India currently has three fulfilment centers in India – one each in Bangalore, Mumbai and Chennai. In July this year, it had stated plans of launching four new fulfillment centers in Delhi, Jaipur, Ahmedabad and Tauru (outskirts of Gurgaon) which were expected to be operational by August this year. Update: An Amazon spokesperson has told Medianama that five of its fulfillment centers are operational and the remaining two (Tauru & Ahmedabad) will be operational soon.

These fulfillment centers are important since it enables merchants to store their inventory in these centers and whenever there is an order placed, Amazon can pack and ship these products across the country. This enables faster delivery of products rather than picking up the product from the merchant after the order has been placed. It also allows merchants to offer products through Amazon’s next day and same day delivery services.

In an interview with Medianama last year, Amit Agarwal, Vice President and Country Manager, Amazon India had also mentioned that its Fulfillment service would allow a seller to be completely egregious about the complexity of moving products across states, taxation, CST, VAT, Octroi, because they have managed to hide that complexity for them. More on that here.

Sales tax problem: Tax authorities however apparently claim that Amazon should pay the sales tax for all the orders through its fulfillment service, since it believes that Amazon owns these goods for all “practical” purposes. Amazon however claims that it is just a service provider and doesn’t own goods at any point of sale, due to which it is not liable to pay this tax.

ED probe on Amazon

It’s worth noting that Karnataka’s commercial taxes department had previously accused Amazon of making a back-door entry in India rather than opening its own subsidiaries. The company however denied these claims stating that it was in compliance of all FDI rules.

There were also reports of an Enforcement Directorate (ED) probe on Amazon India for allegedly violating the FDI rules. ED apparently was looking into whether Amazon has been selling directly to customers under the radar, by making it appear like genuine sales on behalf of vendors.

Remember that India does not allow FDI in multi-brand retail, due to which Amazon currently works as a marketplace, providing a platform for third party merchant to sell goods, and then charge them.

Impact on Amazon India (Our Take)

If this tax issue doesn’t get resolved quickly, it could have significant impact on Amazon’s business operations in India:

Increased costs & delivery time: Amazon will probably have to shut its Bangalore fulfillment center and start delivering orders coming from Karnataka through other fulfillment centers. This will lead to increased costs and delivery time for shipments in the state, since it will probably have to start shipping products from other fulfillment centers in the country.

This could potentially drive consumers to opt for Amazon’s competitors like Flipkart for their purchases since they might be able to deliver products faster. Alternatively, Amazon could also stop delivering products to Karnataka if the issue continues and it becomes unviable for Amazon to continue delivering products to the state.

This problem could further increase for Amazon if other state tax authorities also follow suit. Frankly, this shows how archaic the current tax laws are.

Merchant base: Amazon might find it difficult in signing up new merchants in Karnataka, since they might instead tie-up with its competitors Flipkart or Snapdeal. Livemint cites a source to state that Flipkart’s largest seller WS Retail has not been served a notice yet while Snapdeal doesn’t have a fulfillment center in Karnataka.

This could also result in other e-commerce businesses avoiding Karnataka to set up its fulfillment centers or bring in investments to the state.