In today’s Finshots, we dive into how a two-decade-old matter on the tax treatment of licence fees might finally have closure.
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The Story
Telecom companies just got sucker punched by the Supreme Court of India. And now, they might have to shell out a whopping ₹14,000 crores in taxes!
What’s going on, you ask?
Okay, let’s quickly take it from the top. In the early 1990s, the government made a huge announcement. Private companies could finally enter the telecom industry. We formulated a National Telecom Policy in 1994 and rolled out licences. And the applications poured in.
But the good times didn’t last. Companies found that running a telecom business in India simply wasn’t viable. Why? The costs were prohibitively high. There was an entry fee and fixed* licence fee to be paid to the government each year. And companies weren’t making enough money to cover these costs. The companies suffered losses. Some of them began to default on the fees too. The government realized that something had to change.
*Sidebar: There was a fixed licence fee for the first 3 years and then a minimum fee per subscriber.
So, they tweaked the rules. They issued a revised telecom policy in 1999. And they ditched the fixed licence fee. Instead, they announced that the licence fee would be linked to the annual revenue of a telco. It would be on a percentage basis.
And folks, here’s where the crux of today’s tax battle began.
You see, in the accounting world, you can treat expenses in two ways.
There’s revenue expense. Or the cost incurred by a business to keep its operations ticking. It could be a sum of money spent on maintaining machinery. It could be salaries. It could be utility bills. You get it, anything that’s needed to keep the lights on basically. And the rules say that you can deduct these yearly expenses from the revenues. The tax to be paid to the government is calculated only on the money leftover after these deductions.
Then there’s the capital expense. Think of this as the money spent to acquire things that helps the company actually make profits. It could be land and machinery. It could be computer hardware and software for an IT company. And the rules state that you can amortise these costs. Or simply put, the initial cost of buying these capital assets can be written off over a period of time. In instalments.
Which begs the question — are these annual telecom licence fees a revenue expense that can be written off each year? Or is it a capital expense that has to be split over a longer period? It’s this classification dilemma that became the bone of contention in the 20 year long court battle.
And it all started with the telco Bharti Hexacom (now a subsidiary of Bharti Airtel). When it had to calculate the tax to be paid for the assessment year 2003–04, it looked at the licence fee first. Remember, it was a percentage of revenue by then. And this amounted to nearly ₹12 crores. So Hexacom simply wrote off the entire ₹12 crores as a revenue expense. It deducted this amount from its top line and reduced its tax liability for the year.
But you can bet that the tax authorities were not happy.
They said, “Look, you can’t just deduct the whole thing and avoid paying us the tax for the year. We believe the licence fee is a capital expense. You should amortise it.”
Or simply put, they believed that Bharti Hexacom could only deduct part of the licence fee expense each year. For instance, in this case, since the licence fee was roughly ₹12 crores for the year, they should've deducted only ₹1 crore in the first year. Hexacom could split the rest of the expense over the following 12 years.
That meant Hexacom would have had to add back around ₹11 crores to its bottom line for that year. And then shell out a higher chunk of tax.
Both sides didn’t back down. And the case first went to Income Tax tribunal. They ruled in favour of the telco. Then the case went to the Delhi High Court and the end result was the same. This time, the court actually said that since the telecom policy had changed some rules in 1999, the fees could be split in two ways — the licence fee for 1994–1999 would be treated as a capital expense. And the licence fees post that period would be treated as a revenue expense. Even the high courts of Bombay and Karnataka agreed. It looked like the IT department couldn’t win.
Until the 16th of October…the highest court in the land, the Supreme Court, finally ruled against the telcos. It concluded that the annual licence fee was indeed a capital asset. The IT department was right!
So we pored through the 127 page court document to figure it out how it came to this conclusion.
Now the Supreme Court took numerous examples of cases from the past — both from India and England. And if you’re an aspiring lawyer, you’ll probably love reading the document. But unfortunately, the cases are quite complicated. And this newsletter isn’t going to be a case study of previous judgements, so we won’t delve into their nuances. Rather, we’re simply going to tell you that this judgement actually boils down to one simple principle. A question that the Supreme Court asked — What happens if the telco fails to pay the annual licence fee? Can they still continue to operate the business in some way or the other?
The answer was no. A default would mean a cancellation of the licence. The telco would have to shut down. Basically, that meant the licence to the telco was like machinery to a manufacturing firm. It was intrinsic to setting up the business and generating revenue. Ergo, it’s a capital asset at its core. Also, just because the fee was paid yearly or in instalments, it didn’t change this principle. It was just a way to reduce the burden of a one-shot lumpsum payment.
That’s it. 20 years of debate has ended with just that one principle.
And now, the ruling could put telcos in a soup. They might just need to go back in time and recalculate everything. They’ll have to add back the licence fees they deducted as revenue expense. It will increase the tax liability. They might have to pay penalties too. Ouch.
It was tough being a telco in 1994. It looks like it’s even harder being one in 2023!
Until then…
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