Supreme Court settles the treatment of variable telecom license fees as capital expenditure: CIT vs. Bharti Hexacom Ltd. (16 October 2023)

Introduction

Date of the Judgment: 16 October 2023

Citation: 2023 INSC 917

Judges: B.V. Nagarathna, J. and Ujjal Bhuyan, J.

Can a telecom company treat its annual license fee as a regular business expense, or is it a capital investment? The Supreme Court of India recently addressed this question in a batch of appeals, clarifying whether variable license fees paid by telecom operators should be considered revenue or capital expenditure for tax purposes. This decision has significant implications for how telecom companies manage their finances and taxes.

Case Background

The case involves several telecom companies that had initially obtained licenses under the National Telecom Policy of 1994. These licenses were for a fixed period and involved a fixed fee for the first three years, and a variable fee based on the number of subscribers thereafter. In 1999, the government introduced the New Telecom Policy, which allowed existing licensees to migrate to a new regime. This new policy stipulated a one-time entry fee and a variable license fee based on a percentage of the Annual Gross Revenue (AGR). The telecom companies paid the one-time entry fee and treated it as capital expenditure. However, they claimed the variable license fee as revenue expenditure, which was contested by the Income Tax Department.

Timeline

Legal Framework

The core of the dispute revolves around the interpretation of Section 37 and Section 35ABB of the Income Tax Act, 1961. Section 37 allows deductions for expenses incurred wholly and exclusively for business purposes, while Section 35ABB allows amortization of capital expenditure incurred for acquiring a right to operate telecommunication services. The Indian Telegraph Act, 1885, particularly Section 4, which grants the Central Government the exclusive privilege of establishing, maintaining, and working telegraphs, and Section 8, which allows the government to revoke licenses for breach of conditions, also plays a crucial role in this case.

Section 35ABB of the Income Tax Act, 1961 states:

“35ABB. Expenditure for obtaining licence to operate telecommunication services. —
(1) In respect of any expenditure, being in the nature of capital expenditure, incurred for acquiring any right to operate telecommunication services either before the commencement of the business to operate telecommunication services or thereafter at any time during any previous year and for which payment has actually been made to obtain a licence, there shall, subject to and in accordance with the provisions of this section, be allowed for each of the relevant previous years, a deduction equal to the appropriate fraction of the amount of such expenditure.”

Section 4(1) of the Indian Telegraph Act, 1885 states:

“4. Exclusive privilege in respect of telegraphs, and power to grant licences:–
(1) Within India, the Central Government shall have the exclusive privilege of establishing, maintaining and working telegraphs: Provided that the Central Government may grant a licence, on such conditions and in consideration of such payments as it thinks fit, to any person to establish, maintain or work a telegraph within any part of India:”

Section 8 of the Indian Telegraph Act, 1885 states:

“8. Revocation of licences:– The Central Government may, at any time, revoke any licence granted under section 4, on the breach of any of the conditions therein contained, or in default of payment of any consideration payable thereunder.”

Arguments

Appellant (Income Tax Department):

• The department argued that the variable license fee is essentially a part of the license acquisition cost and should be treated as a capital expenditure.
• The method of payment, whether lump sum or periodical, does not change the nature of the expenditure.
• The license fee, whether entry fee or annual fee, is for securing a license to operate telecom services, and thus is a capital expenditure.
• Section 35ABB of the Income Tax Act, 1961, applies to all payments made for acquiring the right to operate telecommunication services, regardless of the mode of payment.
• The department relied on the decision of the Supreme Court in Aditya Minerals Pvt. Ltd. vs. Commissioner of Income Tax, (1999) 8 SCC 97, asserting that the mode of payment does not determine the nature of expenditure.
• The department contended that the High Court’s reliance on cases like Jonas Woodhead and Sons, Southern Switch Gear Ltd., and Best and Co. was misplaced, as those cases dealt with different subject matters and divisible payments.
• The department also cited CIT vs. Jalan Trading Co. Pvt. Ltd., (1985) 4 SCC 59, to argue that annual payments for the right to carry on business are capital in nature.

Respondent (Telecom Companies):

• The telecom companies argued that the variable license fee is a revenue expenditure, as it is a recurring expense for maintaining and operating the business, not for acquiring the license itself.
• They contended that the one-time entry fee is a capital expenditure, while the variable license fee is a running expense, similar to rent or royalty.
• They highlighted that the 1999 policy changed the license conditions, introducing a multi-operator regime and a variable fee based on AGR, which is not a payment for an enduring benefit.
• The companies argued that Section 35ABB of the Income Tax Act, 1961, applies only to expenditures incurred for acquiring a license, not for continuing to operate under an existing license.
• They relied on Mewar Sugar Mills Ltd. vs. CIT, (1973) 3 SCC 143, and CIT vs. Sarada Binding Works, (1976) 102 ITR 187, to argue that a lump sum payment is a capital expenditure, while a recurring payment based on annual earnings is a revenue expenditure.
• They submitted that the annual license fee is not for acquiring the license, but for operating the license and earning profits, therefore, the same is revenue expenditure.
• They also contended that the interpretation of the department would lead to an absurd result where the deduction under Section 35ABB would exceed the actual payment made by the assessee in later years.

Submissions by Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether the variable annual license fee paid by the respondents-assessees to the DoT under the Policy of 1999 is revenue in nature and is to be allowed deduction under Section 37 of the Act, or, the same is capital in nature and is accordingly required to be amortized under Section 35ABB of the Act?
2. Whether the High Court of Delhi was right in apportioning the license fee as partly revenue and partly capital by dividing the license fee into two periods, that is, before and after 31st July, 1999 and accordingly holding that the license fee paid or payable for the period upto 31 July, 1999 i.e. the date set out in the Policy of 1999 should be treated as capital and the balance amount payable on or after the said date should be treated as revenue?
3. What order?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered various cases and legal provisions while arriving at its decision, categorized by legal point:

On the nature of capital expenditure:

• Alembic Chemical Works Co. Ltd. vs. CIT, (1989) 3 SCC 329: This case established that there is no single definitive criterion to determine capital expenditure and that the “once for all” and “enduring benefit” tests may not be conclusive.
• Empire Jute Co. Ltd. vs. Commissioner of Income Tax, (1980) 124 ITR 1: This case highlighted that the “enduring benefit” test should not be applied mechanically and that practical and business considerations are important.
• Assam Bengal Cement Co. Ltd. vs. CIT, West Bengal, (1955) 27 ITR 34: This case held that payments for acquiring a lease of mining stone quarries are capital expenditure.
• Board of Agricultural Income Tax, Assam vs. Sindhurani Chaudurani, (1957) 32 ITR 169: This case stated that lump sum payments for settlement of agricultural land are capital payments.
• Enterprising Enterprises vs. Deputy Commissioner of Income Tax, (2007) 293 ITR 437: This case affirmed the distinction between royalty/rent and lease premium, with the latter being capital expenditure.
• Aditya Minerals Pvt. Ltd. vs. Commissioner of Income Tax, (1999) 8 SCC 97: This case established that the mode of payment (lump sum or periodic) does not determine the nature of capital expenditure.
• CIT vs. Jalan Trading Co. Pvt. Ltd., (1985) 4 SCC 59: This case held that annual payments for the right to carry on business are capital in nature.
• Pingle Industries Ltd. vs. CIT, (1960) 40 ITR 67 (SC): This case held that a lump sum payment in installments for acquiring a lease to mine stones is a capital expenditure.

On the nature of revenue expenditure:

• Mewar Sugar Mills Ltd. vs. CIT, (1973) 3 SCC 143: This case distinguished between payments for monopoly rights (capital) and royalty on manufactured goods (revenue).
• CIT vs. Sarada Binding Works, (1976) 102 ITR 187: This case held that a fixed annual sum for the right to run a business is capital, while royalty based on annual earnings is revenue.
• Travancore Sugars and Chemicals Ltd. vs. Commissioner of Income-tax, (1966) 62 ITR 566 (SC): This case held that payments related to annual profits are revenue expenditures.
• Gotan Lime vs. CIT, (1999) 239 ITR 718: This case held that royalty paid for excavating limestone is a revenue expenditure.
• Commissioner of Income Tax, Bombay City I vs. CIBA India Ltd., (1968) 69 ITR 692 (SC): This case held that payments for the right to access technical knowledge and use patents/trademarks are revenue expenditures.
• Jabbar (M.A.) vs. Commissioner of Income Tax, Andhra Pradesh, (1968) 68 ITR 493 (SC): This case held that payment for a short-term lease to quarry sand is a revenue expenditure.
• Lakshmiji Sugar Mills Co. Pvt. Ltd. vs. Commissioner of Income Tax, (1972) 82 ITR 376 (SC): This case held that expenditures for road construction to facilitate business are revenue expenditures.
• Devidas Vithaldas and Co. vs. C.I.T., Bombay City, (1972) 3 SCC 457: This case held that payments for the right to use goodwill are revenue expenditures.
• Commissioner of Income Tax vs. Associated Cement Companies Ltd., (1988) 172 ITR 257 (SC): This case held that expenditures for securing immunity from municipal taxes are revenue expenditures.
• Honda Siel Cars India Ltd. vs. Commissioner of Income Tax, Ghaziabad, (2017) 8 SCC 170: This case held that lump-sum fees for a limited-period license to manufacture cars are revenue expenditures.

Cases distinguished by the court:

• Jonas Woodhead and Sons Ltd. vs. Commissioner of Income Tax, (1997) 224 ITR 342: Distinguished on the basis that the case dealt with different subject matters and divisible payments.
• Southern Switch Gear Ltd. vs. CIT, (1998) 232 ITR 359: Distinguished on the basis that the case dealt with different subject matters and divisible payments.
• CIT, Madras vs. Best and Co. (Pvt.) Ltd., (1966) 60 ITR 11: Distinguished on the basis that the case dealt with different subject matters and divisible payments.

Legal Provisions:

• Section 37 of the Income Tax Act, 1961 (deduction of business expenses)
• Section 35ABB of the Income Tax Act, 1961 (amortization of telecom license expenditure)
• Section 4 of the Indian Telegraph Act, 1885 (grant of licenses)
• Section 8 of the Indian Telegraph Act, 1885 (revocation of licenses)

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

•Alembic Chemical Works Co. Ltd. vs. CIT, (1989) 3 SCC 329: Cited for establishing that there is no single definitive criterion to determine capital expenditure.

•Empire Jute Co. Ltd. vs. Commissioner of Income Tax, (1980) 124 ITR 1: Cited for highlighting that the “enduring benefit” test should not be applied mechanically.

•Assam Bengal Cement Co. Ltd. vs. CIT, West Bengal, (1955) 27 ITR 34: Cited for holding that payments for acquiring a lease of mining stone quarries are capital expenditure.

•Board of Agricultural Income Tax, Assam vs. Sindhurani Chaudurani, (1957) 32 ITR 169: Cited for stating that lump sum payments for settlement of agricultural land are capital payments.

•Enterprising Enterprises vs. Deputy Commissioner of Income Tax, (2007) 293 ITR 437: Cited for affirming the distinction between royalty/rent and lease premium.

•Aditya Minerals Pvt. Ltd. vs. Commissioner of Income Tax, (1999) 8 SCC 97: Cited to assert that the mode of payment does not determine the nature of expenditure.

•CIT vs. Jalan Trading Co. Pvt. Ltd., (1985) 4 SCC 59: Cited to argue that annual payments for the right to carry on business are capital in nature.

•Mewar Sugar Mills Ltd. vs. CIT, (1973) 3 SCC 143: Distinguished, court held that the royalty was distinct from the payment for monopoly rights.

•CIT vs. Sarada Binding Works, (1976) 102 ITR 187: Distinguished as the case dealt with royalty on sales which was distinct from the right to run business.

•Jonas Woodhead and Sons Ltd. vs. Commissioner of Income Tax, (1997) 224 ITR 342: Distinguished as the case dealt with different subject matters and divisible payments.

•Southern Switch Gear Ltd. vs. CIT, (1998) 232 ITR 359: Distinguished as the case dealt with different subject matters and divisible payments.

•CIT, Madras vs. Best and Co. (Pvt.) Ltd., (1966) 60 ITR 11: Distinguished as the case dealt with different subject matters and divisible payments.

•Gotan Lime vs. CIT, (1999) 239 ITR 718: Cited to show the distinction between payment for acquiring a right and payment of royalty.

•Travancore Sugars and Chemicals Ltd. vs. Commissioner of Income-tax, (1966) 62 ITR 566 (SC): Cited to show that payments related to annual profits are revenue expenditures.

•Commissioner of Income Tax, Bombay City I vs. CIBA India Ltd., (1968) 69 ITR 692 (SC): Cited to show that payments for the right to access technical knowledge and use patents/trademarks are revenue expenditures.

•Jabbar (M.A.) vs. Commissioner of Income Tax, Andhra Pradesh, (1968) 68 ITR 493 (SC): Cited to show that payment for a short-term lease to quarry sand is a revenue expenditure.

•Lakshmiji Sugar Mills Co. Pvt. Ltd. vs. Commissioner of Income Tax, (1972) 82 ITR 376 (SC): Cited to show that expenditures for road construction to facilitate business are revenue expenditures.

•Devidas Vithaldas and Co. vs. C.I.T., Bombay City, (1972) 3 SCC 457: Cited to show that payments for the right to use goodwill are revenue expenditures.

•Commissioner of Income Tax vs. Associated Cement Companies Ltd., (1988) 172 ITR 257 (SC): Cited to show that expenditures for securing immunity from municipal taxes are revenue expenditures.

•Honda Siel Cars India Ltd. vs. Commissioner of Income Tax, Ghaziabad, (2017) 8 SCC 170: Cited to show that lump-sum fees for a limited-period license to manufacture cars are revenue expenditures.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

Sentiment Analysis:

The court emphasized the following points in its reasoning:

• The license fee, whether entry or annual, is for securing the license to operate telecom services.
• The mode of payment does not change the nature of the expenditure.
• The variable license fee is part of the license acquisition cost, not a revenue expense.
• The license is a composite right, and the mode of payment does not change its capital nature.
• The annual payment is a continuation of the payment pre 31 July, 1999.
• The nature of payment for the same purpose cannot have a different characterization merely because of the change in the manner or measure of payment.
• The payment is intrinsic to the existence of the license as well as the trade itself.

Sentiment Analysis of Reasons Given by the Supreme Court

Fact:Law Ratio

The court primarily focused on the legal interpretation of the relevant provisions and precedents, with a lesser emphasis on the factual aspects of the case

Implications

The Supreme Court’s ruling has significant implications for telecom companies and the tax landscape:

• Financial Impact: Telecom companies will now have to treat their variable license fees as capital expenditure, which will affect their profit and loss statements. This means they cannot immediately deduct the annual license fee as a business expense but must amortize it over the license period.
• Tax Planning: This decision will require telecom companies to adjust their tax planning strategies. They will need to account for the amortization of license fees under Section 35ABB of the Income Tax Act, 1961.
• Consistency: The ruling provides clarity and consistency in the treatment of telecom license fees, which had been a contentious issue for many years.
• Revenue for the Government: The government will likely see an increase in tax revenue as telecom companies will not be able to claim the annual license fee as a revenue expense.
• Future Licenses: The judgment will likely influence the structuring of future telecom licenses and the terms of payment.

Flowchart of the Decision

Conclusion

The Supreme Court’s judgment in CIT vs. Bharti Hexacom Ltd. has definitively settled the long-standing debate on the treatment of variable telecom license fees. By ruling that these fees are capital expenditure and not revenue expenditure, the court has provided much-needed clarity and consistency to the tax treatment of such payments. This decision will have a significant impact on the financial reporting and tax planning of telecom companies in India. The court’s emphasis on the nature of the payment as being for the right to operate telecom services, rather than a recurring expense, was crucial in its determination. The judgment underscores the importance of adhering to the specific provisions of the Income Tax Act and the Indian Telegraph Act, and the principle that the mode of payment does not change the nature of the expenditure.