Supreme Court's Telecom License Diktat May Spill Over To Other Sectors

The latest Supreme Court judgement on the classification of licence fees as capital expenditures for telecom companies may have a ripple effect on other sectors with similar transaction structures.

Sectors that have a one-time lump-sum fee followed by recurring payments at regular intervals, like mining contracts, may also come under the Income Tax Department’s scanner.

While it is important to look at the terms of such licences, it opens up these issues to litigation, according to Frank D’Souza, partner at Price Waterhouse Co. “The spillover of this judgement is not limited to government licences, but even in private contracts like franchisees that follow similar transactional structures.”

However, it may not apply in every case, but it goes against the "conventional wisdom” that was being followed for a long time.

In 2013, the Delhi High Court held that payment of the licence fee was partly capital in nature and party revenue in nature. It said that the one-time payment was capital in nature, and the variable yearly payments were revenue.

The Supreme Court overturned the Delhi High Court's judgement, saying that the variable licence fee, which is paid yearly, cannot be reclassified as a revenue expenditure. The payment of an amount in installments does not convert the nature of a capital payment into a revenue payment, it said.

“The issue of what is revenue expenditure versus capital expenditure relating to payments made to obtain certain rights has been a vested issue,” D’Souza said, adding that litigation is arising as income tax law lacks a codified definition of ‘capital assets’.

The decision may be extended to sectors like mining companies and other businesses that pay licence fees or royalties, said Madhava Yathigiri, partner at Deloitte India.

However, since franchisee agreements aren’t for a long period compared to the life of licences, whose lives usually go into multiple decades by telecom companies and mining companies, the tax department is unlikely to move against such private contracts, he said.

The judgement is unlikely to have carte blanche applicability.

The apex court, in its judgement, observed that there is a distinction between payment made to acquire a right vis-à-vis payment of royalty for use of a right or an asset, said Naveen Aggarwal, office managing partner, Delhi and partner, tax at KPMG India.

Unless the precedent has been rendered in an identical factual situation, it is not suitable to apply the dictum of one case, premised on the facts of the said case, to another situation that is seemingly similar, he said.

“One needs to look at various factors, such as the object of the licence arrangement, the basis of annual licence fee payments, the impact of default in the payment of licence fees on the continuity of the licence, etc., to determine whether the principles laid out in the apex ruling can be extended beyond the telecom sector,” Aggarwal said.

While analysts and tax practitioners expect an increased tax outflow in the beginning years of the life of the licence, it will also accumulate a deferred tax asset, which will reduce the tax in the final years of the licence.

Kotak Securities Ltd. has pegged a demand of up to Rs 8,400 crore and Rs 6,000 crore from Reliance Jio Infocomm Ltd. and Bharti Airtel Ltd., respectively. “We believe the income tax authority could raise demand for the shortfall in taxes for the prior period, along with applicable penalties, which could lead to a potential significant one-time impact,” Kotak said.

In the case of loss-making entities, they may see contraction in such losses to the extent of deductions in respect of licence fees treated as revenue expenditures, Yathagiri said.

However, the ability of the income tax authority to reopen past years is constrained.

While the judgement is retrospective in nature, “demands can be made, provided the income tax department has contested your position in those specific years,” D’Souza said.

There will be no impact of the ruling on the accounting treatment of licence fees. “From a tax perspective, the way you account for your tax liabilities and tax assets changes. Contingent liabilities will also undergo a change as the issue is now settled,” he said.

The tax authorities may seek to initiate re-assessments by invoking an extended time limit and may also levy interest and penalties. However, the penalty may be defendable, according to Yathagiri.

However, Kotak Securities expects a prima facie accounting change that will lead to higher operating profit and profit before tax.

While the telecom companies have the option to file for a review of the Supreme Court’s decision, D’Souza said it is unlikely to see a different outcome, considering the counterarguments made by the court on the issue.