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Telecom License fee is a capital expenditure: The Supreme Court says

With the Supreme Court’s judgement noting license fees are a part of capital expenditure, telcos would now have to look at years worth of tax records (starting from 1999) and make the necessary payments. 

Supreme Court
Credit: Aditi Agrawal

The Supreme Court of India said that license fees paid by telecom companies will be considered a capital expenditure in its judgment on a court case between the telecom company Bharti Hexacom Limited and the Income Tax (IT) Department on October 16. According to a report by the Economic Times, this change in classification will be a setback to telcos like Bharti Airtel and Vodafone Idea who will now have to reassess their financial structures and potentially face increased tax liabilities. It estimates that the top telecom companies could collectively face additional tax liabilities of Rs 8,000 crore as a result of this judgment. 

This case has been tried multiple times with the Delhi High Court in 2013 suggesting that license fee payment was a capital expense in part and revenue in part and that it would not be correct to hold that the whole fee was capital or revenue in nature in its entirety. “Perhaps, the decision of the High Court could have been sustained if the facts were such that even if the respondents-operators did not pay the annual license fee based on [adjusted gross revenue] AGR, they would still be able to hold the right of establishing the network and running the telecom business. However, such a right is not preserved under the scheme of the Telegraph Act,” The Supreme Court said.

Some context:

In 1999, a new licensing policy was introduced (The National Telecom Policy, 1999) under which telecom operators who wanted a license to operate in India would be required to pay a one-time entry fee and additionally a license fee on a percentage share of the telco’s AGR. This license would be applicable for a period of 20 years from the effective date of the previous license agreement (that is, the 1994 agreement). This essentially meant that telcos who already had a license would just migrate from the previous one to the 1999 license agreement. The entry fee for the license would be payable on 31 July 1999. 

So, what happened?

In 2004, the telco Bharti Hexacom Limited filed its income tax returns declaring nil income. When these returns were processed by the IT Department, the authority noted that an amount of Rs. 11.88 crores which was paid as a license fee had been listed by the company as a revenue expense. The IT department argued that the license fee which was being claimed as a revenue expense, should instead be spread over the remainder of the license period (which was 12 years at the time of the conflict). Accordingly, the IT department said that an amount of 99.06 lakh was allowed as a deduction under section 35abb of the Income Tax Act but the remaining amount of Rs. 10.89 crore should be added back to the income of Bharti Hexacon. 

This case was heard by the Commissioner of Income Tax (Appeal), who sided with Bharti Hexacom, stating that license fees would be classified as revenue expense. Then, the case went to the Delhi High Court which held that the fee paid before that had been paid or was payable for the period up to 31 July 1999 should be treated as a capital expense and the balance amount payable on or after that date should be treated as a revenue expense. 

What is the difference between revenue and capital expenditure?

Revenue expense (OPEX) is the cost incurred by a business during the course of operations and does not typically boost the profit generation capacity of the business. Some revenue expenditures include rent, and salaries. On the other hand, capital expense (CAPEX) is the money spent to acquire, maintain or upgrade long-term assets. These expenses include the purchase of tangible assets like a plant and equipment or a plot of land for the business. 

Revenue expenses are generally fully deductible from taxable income in the year they are incurred, while capital expenditures are not. When the Commissioner of Income Tax (Appeal) had heard the case initially, it had classified license fee as a revenue expense under Section 37 of the Income Tax Act. 

Why does this matter?

With the Supreme Court’s saying that license fees are a part of capital expenditure, telcos would have to look at years worth of tax records (starting from 1999) and make the necessary payments

“The various telecom operators who have incurred substantial expenses to obtain [a] licence will have to revisit the position taken with respect to the deductibility of the expense. The disallowance of the expenses would adversely impact the companies which are already suffering [a] huge loss,” Mihir Gandhi, partner, tax and regulatory services at the network of accounting, tax and advisory firms BDO India told MediaNama. 

Details of the Supreme Court’s judgment: 

The Supreme Court said that the determinative test to identify whether an expense structured in the form of installments (like the license fee)  is capital or revenue in nature would be to see whether it, “relates to the acquisition or expansion of a capital asset, or by contrast, relates to the working of an asset to produce profits,” and whether the payment towards the acquisition of a capital asset has been sliced into smaller parts simply for the sake of convenience. 

The court held that both the entry fee and the annual license fee relate to a single purpose, that is, the acquisition of the right to carry on a telecom business. “This right being in the nature of a capital asset, any payment(s) made towards the acquisition of the right, whether in lump-sum or in annual installments dependent on the AGR, would be in the nature of capital disbursement(s),” it explained. 

Unlike the Delhi High Court’s suggestion of breaking the license fee into both revenue (yearly fee) and capital expense (entry fee), the Supreme Court said that the nature of the two payments would only be different if there was “no nexus with the original obligation” of the license holder. “A single transaction [the license fee] cannot be split up, in an artificial manner into a capital payment and revenue payments by simply considering the mode of payment,” it held, explaining that both payments relate to the same obligation— payment of license fee as consideration for the right to establish, maintain and operate telecommunication services as a composite whole. 

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