Monday 20 February 2012

Treatment of Spectrum Charges in Income tax act 1961.

IN THE MATTER OF

Whether payment of Spectrum charges gets covered under section 35ABB or Section 37 of the Income Tax act 1961?

 

FACTS

The company is engaged in the business of providing telecommunication facilities (just like MTNL/BSNL) to their subscribers. It has been granted licenses for operating in its specified circle. License means a License granted or having effect as if granted under section 4 of the Indian Telegraph Act 1885 and Indian Wireless Act 1933.
The license permits MTNL to provide, in its area of operation, all types of mobile services including voice and non-voice messages, data services and PCOs utilizing any
type of network equipment. In lieu of this license, there is a certain fee that was paid by MTNL to the Government of India .This fee had three components:

·         Entry Fee: A One –Time Entry Fee which was paid by the company based on the bidding process prior to signing of this license agreement.

·         License Fees:  In addition to the Entry fee described above, the company also pays Licence fee annually at a certain % of Adjusted Gross Revenue (AGR), excluding spectrum charges. . Licence fee is the price for the consideration which the Government charges to the licensees for parting with its privileges and granting them to the licensee and such a charge is the normal incident of a trading or business transaction. The amount charged to the licensees is in the nature of the price of the privilege which the purchaser has to pay in any trading or business transaction

·         Radio Spectrum Charges: In addition, the company also pays spectrum charges on revenue share basis of 2% of AGR towards WPC Charges covering royalty payment for the use of cellular spectrum upto 4.4 MHz + 4.4 MHz and Licence fee for Cellular Mobile handsets & Cellular Mobile Base Stations and also for possession of wireless telegraphy equipment as per the details prescribed by Wireless Planning & Coordination Wing (WPC).

As per the terms of License, any additional band width, if allotted subject to availability and justification attracts additional Licence fee as revenue share (typically 1% additional revenue share if Bandwidth allocated is upto 6.2 MHz + 6.2 MHz in place of 4.4 MHz + 4.4 MHz).

Till date, MTNL has been claiming the annual license fees and spectrum charges paid by it as a revenue expenditure allowable u/s 37 of the Income tax Act.
However, in the light of certain reforms in the telecommunication sector relating to allocation of additional spectrum, a new controversy has arisen.
The question to be considered is that whether the spectrum charges gets covered under section 35 ABB or section 37 of the income tax act?

In this regard, it is first of all important to understand the meaning of Spectrum and the recent developments in the telecom sector.

SPECTRUM:
Meaning:
Spectrum means the distribution of wavelengths and frequencies that exist in a continuous range and have a common characteristic, containing electromagnetic frequencies used for electronic communications including, amongst other things, mobile communications.

WPC i.e. Wireless and Planning Co-ordination Wing of the DOT is responsible for identification and allocation of frequency spectrum to telecommunications services provider
Spectrum and Mobile Telephone Services:
Mobile telephone service providers in India use GSM (Global System for Mobile Communications) and CDMA (Code Division Multiple Access) technologies. GSM technology works in the frequency bands of 900 and 1800 MHz in India and CDMA technology works in the 800 MHz band. 800, 900 and 1800 MHz bands were earlier allotted to the defence services for their mobile communication usage. However, upon the launch of mobile communication services for public, coordination was sought from the defense department to make the spectrum available for mobile services. Since the mobile communication technologies provide international roaming facilities, it is essential to allocate spectrum in the common bands which are being used the world over.
Spectrum Allotment Procedure
In the case of licensed telecom service provider’s spectrum was initially allotted in accordance with the relevant provisions of the service license agreements. However, due to an exponential increase in the number of mobile subscribers additional mobile is required by the mobile operators. Serving a larger number of subscribers requires either a larger amount of spectrum or an increase in the number of base stations. Therefore, additional spectrum is required at some stage as a techno economic solution to meet the growth of mobile services. Department of Telecommunications has evolved guidelines for the allotment of extra spectrum, based on the justification and fulfillment of the prescribed criteria.
ISSUE UNDER CONSIDERATION:
Spectrum allocation enables the telecom operator to carry on the wireless communication. It is certainly not possible to start a wireless service without being allocated spectrum. At present, there are three bands, 800 MHz, 900 MHz and 1,800 MHz, from which spectrum is allocated. If, however, a provider is initially allotted bandwidth in a particular band, and adds numbers slowly, further allocation may be in a different band. 

Spectrum is not acquired separately by the operators; it is bundled along with the license. Additional spectrum is made available only after existing allotments are fully utilised.

Spectrum charges:
Spectrum charges are charges (based on our AGR) paid to Wireless Planning Commission (“WPC”) for use of allocated spectrum.
There are two parts in spectrum usage charges.  One is the entry fee for the right to use spectrum and the other is annual usage charge.
As mentioned before, there are certain charges that are paid for the usage of spectrum annually, besides an upfront lump sum fees (payable one time) for spectrum allocation.
In a telecom company, like MTNL, operating expenses generally includes expenses incurred by it for network operation and maintenance including annual spectrum usage charges, interconnect charges, roaming charges, operating lease charges, fuel and power charges, repair and maintenance charges and other miscellaneous expenses.
Similarly, in case the company applies for additional spectrum, the amount paid by it to the government for acquisition of the same is treated as a capital expenditure. Network and equipment requirements in the telecom industry are capital intensive.
Thus, the treatment of these spectrum charges as per Income Tax Act 1961 should be as follows:
·         Lump sum spectrum allocation fee: (Spectrum Auction Price/ Spectrum Acquisition Charges) it is a capital expenditure as it enables the telecom company to get the right of using the spectrum. Lump sum spectrum charge should be explicitly allowed to be amortized evenly over the license period under section 35ABB of the Act.
·         Annual Spectrum usage charges: These are revenue expenses just like annual license fees and hence must be claimed as per section 37 of the income tax act 1961.
The relevant provisions and judicial pronouncements are being reproduced as under-

A. Relevant Provisions of the income tax Act 1961 :
1.     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.
Explanation.---For the purposes of this section,--
(i) "relevant previous years" means,---
(A) in a case where the licence fee is actually paid before the commencement of the business to operate telecommunication services, the previous years beginning with the previous year in which such business commenced;
(B) in any other case, the previous years beginning with the previous year in which the licence fee is actually paid,
and the subsequent previous year or years during which the licence, for which the fee is paid, shall be in force;
(ii) "appropriate fraction" means the fraction the numerator of which is one and the denominator of which is the total number of the relevant previous years;
(iii) "payment has actually been made" means the actual payment of expenditure irrespective of the previous year in which the liability for the expenditure was incurred according to the method of accounting regularly employed by the assessee………”
Analysis of Section 35 ABB:
Conditions on the basis of which deduction shall be allowed are:
Ø      Capital Expenditure
Ø      Acquiring any right to operate telecommunication services
Ø      Incurred before or after commencement of Business
Ø      Mainly incurred to obtain license.
Ø      If conditions fulfilled, then claim can be done u/s 35ABB otherwise u/s 37(1) as business expenditure.
Hence, Lump sum spectrum allocation fee, being a capital expenditure must be claimed u/s 35ABB of the Act.

2.    37. General.
“(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession".
Explanation.-For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.”
Analysis of General deductions [37(1)]
Ø      It should not be a capital expenditure or
Ø      Not personal
Ø      Not prohibited by law such as fine, penalty
Ø      Not be an illegal expenditure
Hence, Annual Spectrum usage charges, being revenue expenses in nature, are allowable u/s 37 of the Act.


B. Why is the license fees paid by MTNL claimed u/s 37 and not 35ABB i.e. how can the treatment of license fees and that of spectrum charges be different? :

1.    Mahanagar Telephone Nigam Limited. vs. Additional Commissioner Of Income-Tax. (100 TTJ 1) given by ITAT DELHI-G Bench on 3/2/2006

In this case, the issue of non applicability of sec 35 ABB to MTNL was discussed; the relevant extracts are as follows:

“However, in the case of MTNL it has been the stand of the Department that the provisions of s. 35ABB are not attracted, as this section deals with the tax treatment to be given in respect of expenditure that had actually been incurred to obtain licence. In the instant case, MTNL came into existence in the year 1986, and from its inception it was paying licence fee @ Rs. 101 per annum. As such the subsequent increase in the fee from asst. yr. 1994-95 onward cannot be treated as an amount paid to obtain the licence. In this background it may be pointed out that in cases of other operators the factual position is as under:
(vi) In the case of Reliance Telecom the basic telephone services commenced from March, 2000, and the licence fee paid upto 31st March, 2000 was Rs. 1,79,08,58,630. The licence period remaining in the year ended 31st March, 2000 was 17 years, and the licence fee was apportioned over the remaining 17 years. Thus, there is no dispute over the Department and the assessee on this point. The apportionment is based on unexpired period of licences from the date of the payment of the licence fee or commencement of business, whichever is later.
(vii) M/s Bharati Cellular Ltd. was incorporated on 20th March, 1992 for asst. yr. 2002-03 the assessee had claimed an amount of Rs. 65,15,10,000 on account of licence fee. However, invoking the provisions of s. 35ABB only a licence fee amounting to Rs. 4,07,19,375 was allowed, and the balance of Rs. 61,07,90,625 was disallowed.
42. In the cases of private operators, licence has been given for a definite period, e.g., in the cases of Reliance Telecom Ltd. and Bharati Cellular Ltd., licence has been given for a period of 20 years. However, in the assessee's case, licence has been given on year-to-year basis as has been seen from the OMs filed by the assessee in this regard.”
2.    Decision of ITAT Mumbai in ITA/1434/Mum/99 in the case of Videsh Sanchar Nigam Ltd. Vs. CIT.dated 14/9/2000.(69 TTJ 882)
In this case it was discussed that “the assessee cannot provide the services relating to international telecommunication without making use of the network provided by the DOT. Thus, the utilisation of the network owned by the DOT is inextricably bound up with the services relating to International telecommunication provided by the assessee to the public at large from which it earns income. In Bombay Steam Navigation's Co. 1953 Ltd.'s case, it was held that the question whether a particular expenditure is revenue expenditure incurred for the purpose of business must be viewed in the larger context of business necessity or expediency. It was held that if the outgoing or expenditure is so related to the carrying on or the conduct of the business, that it may be regarded as an integral part of the profit earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition to the carrying on of the business, the expenditure may be regarded as revenue expenditure. The payment made by the assessee in the present case satisfies this test.”
Mumbai ITAT held that licence fees paid by assessee company in terms of licence granted to it under the relevant provisions for use of telephone net work covered by DOT to provide international telecom services to public being a payment related to conduct of assessee’s business the same was allowable as business expenditure, there being no enduring advantage.
It was held that
In the result, we hold that the amount of Rs. 282.60 crores paid by the assessee to DOT as licence fees is an allowable expenditure under section 37(1) of the Act in computing the profits of the assessee's business. The appeal is allowed.”



3.    As per a recent judgement of ACIT vs. Vodafone Essar Gujarat Ltd. (2010) 38 SOT 51 (Ahd.) :
Fees paid by assessee Telecom Company to department of telecommunication for use of licence was to be allowed as revenue expenditure.

The view expressed in the abovementioned judgement clearly specifies that
Ø      The license fees paid by MTNL is on annul basis.
Ø      This fees is allowable as a business expenditure as per Section 37 of the act.


However, in regard to spectrum charges, the treatment would be slightly different
Ø      The spectrum acquisition charges i.e. lump sum charges paid one time for the acquisition of additional spectrum are capital expenditure as it gives the company, a right to use the alloted Spectrum. Hence, it will be allowed under section 35ABB of the act.

Ø      The annual spectrum charges, which are based on a certain percentage of revenue, are however, revenue expenses allowable u/s 37 of the act.

In regard to spectrum acquisition charges, there are various representations from TRAI, AUSPI, COAI etc. that the upfront spectrum charges, allowable over appropriate previous years as per Section 35 ABB, should be allowed totally onetime in the year of payment.
These representations also support our view point that the spectrum acquisition charges are allowable under section 35 ABB of the act and not section 37. Annual spectrum charges, however, in our opinion, are allowable under section 37 of the Income Tax Act 1961.

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