MUMBAI: The Supreme Court (SC) held yesterday that the annual license fee paid by telecommunications companies to be a capital expenditure. This decision overturns the judgment of the Delhi High Court, passed in December 2013, which classified the license fees as partly revenue and partly capital in nature.
Presently, telecom firms treat these fees (paid post July 31, 1999), when the new Telecom Policy came into effect, as an expense. This is a business deduction and lowers the taxable income and hence the Income-tax (I-T) outgo or if the company is loss making, it increases the taxable losses that can be carried forward to future years. Pursuant to the SC’s order, the fees will be capital in nature entitled to amortization over the license’s duration.
On December 18, 2013, the Delhi High Court, (in the case of Bharti Hexacom and others) held that the payment of licence fee was partly capital and partly revenue in nature. It held that licence fee payable up to 31 July 1999 should be treated as capital expenditure and licence fee on revenue sharing basis after 1 August, 1999 should be treated as revenue expenditure.
The Supreme Court rejected the high court’s order. It emphasized that terminology and payment method are irrelevant in determining the payment’s nature. It also disapproved of the high court’s artificial division, which categorized fees before and after July 31, 1999 differently.
According to market analysts, initially, this accounting change is expected to boost EBITDA/PBTratio while increasing the tax outlay. Nevertheless, these effects are likely to level out over the license holding period. It is anticipated that telecom companies will file review petitions. There is potential for retrospective tax demands with penalties, but the exact impact remains uncertain, say market analysts. There is also a possibility that the impacted telecom companies may file for a review petition.
Soumyadip Roychoudhury, tax partner, at BDO India, states that this verdict would have an immense impact not just in telecom industry but across other industries as well. This would again spark the debate of license fees being revenue or capital in nature and would create precedence for future litigations.”
According to Morgan Stanley Research, the change in accounting treatment could lead to accrual of higher taxes in the initial period of the license but potentially offset in later years through higher depreciation and amortization charges. So, over a period of 20 years (the term of the license period), it may get offset, although there could be some impact on Net Profit Value (NPV) given up-fronting of higher taxes in the initial period. Companies with past accumulated losses would have an option to offset some of this near-term impact as well.
“Hence, we believe the impact appears quite manageable. We await clarity and can’t rule out any potential dues to be paid by the telecom service providers pertaining to past periods based on the SC’s order,” it states.
According to Kotak Institutional Equities, For telcos, which have completed the initial 2 0 years
of the license, the past tax shortfall would likely pertain only to the difference in payment timings and change in tax rate, in our view. However, there could be a significant impact of tax shortfall if 1) the telco is still to complete the initial 20-year license period or 2) for the period after license renewal. We have not incorporated potential tax liabilities for telcos in our model, as we await more clarity on the actual amount and potential penalties (if any).
Presently, telecom firms treat these fees (paid post July 31, 1999), when the new Telecom Policy came into effect, as an expense. This is a business deduction and lowers the taxable income and hence the Income-tax (I-T) outgo or if the company is loss making, it increases the taxable losses that can be carried forward to future years. Pursuant to the SC’s order, the fees will be capital in nature entitled to amortization over the license’s duration.
On December 18, 2013, the Delhi High Court, (in the case of Bharti Hexacom and others) held that the payment of licence fee was partly capital and partly revenue in nature. It held that licence fee payable up to 31 July 1999 should be treated as capital expenditure and licence fee on revenue sharing basis after 1 August, 1999 should be treated as revenue expenditure.
The Supreme Court rejected the high court’s order. It emphasized that terminology and payment method are irrelevant in determining the payment’s nature. It also disapproved of the high court’s artificial division, which categorized fees before and after July 31, 1999 differently.
According to market analysts, initially, this accounting change is expected to boost EBITDA/PBTratio while increasing the tax outlay. Nevertheless, these effects are likely to level out over the license holding period. It is anticipated that telecom companies will file review petitions. There is potential for retrospective tax demands with penalties, but the exact impact remains uncertain, say market analysts. There is also a possibility that the impacted telecom companies may file for a review petition.
Soumyadip Roychoudhury, tax partner, at BDO India, states that this verdict would have an immense impact not just in telecom industry but across other industries as well. This would again spark the debate of license fees being revenue or capital in nature and would create precedence for future litigations.”
According to Morgan Stanley Research, the change in accounting treatment could lead to accrual of higher taxes in the initial period of the license but potentially offset in later years through higher depreciation and amortization charges. So, over a period of 20 years (the term of the license period), it may get offset, although there could be some impact on Net Profit Value (NPV) given up-fronting of higher taxes in the initial period. Companies with past accumulated losses would have an option to offset some of this near-term impact as well.
“Hence, we believe the impact appears quite manageable. We await clarity and can’t rule out any potential dues to be paid by the telecom service providers pertaining to past periods based on the SC’s order,” it states.
According to Kotak Institutional Equities, For telcos, which have completed the initial 2 0 years
of the license, the past tax shortfall would likely pertain only to the difference in payment timings and change in tax rate, in our view. However, there could be a significant impact of tax shortfall if 1) the telco is still to complete the initial 20-year license period or 2) for the period after license renewal. We have not incorporated potential tax liabilities for telcos in our model, as we await more clarity on the actual amount and potential penalties (if any).
