By TIOL News Service

NEW DELHI, DEC 25, 2013: THE issues before the Bench are - Whether the enduring benefit test has limitation and cannot be mechanically applied without considering the commercial or business aspects; Whether practical and pragmatic view and considerations rather than juristic classification is the determinative factor; Whether payment of licence fee can be partially capital and revenue in nature when one part is meant for acquiring the right to operate as telecom operator and other to continue the business; Whether the payment of yearly licence fee on revenue sharing basis under the New Telecom Policy of 1999 for carrying on business as cellular telephone operator is in the nature of capital expenditure amortizable as per section 35ABB of the Act and Whether Section 35ABB by itself can decide the question whether licence fee paid under the New Telecom Policy 1999 or under the 1994 agreement, was/is capital or revenue in nature. And the verdict partly favours the assessee.

Facts of the case

The assessee companies, ie., Bharti Cellular Ltd., Bharti Hexacom Ltd. and Bharti Airtel Ltd are engaged in business of telecommunication services and value added related services. They have procured licence in different circles. Originally the said licences were awarded under licence agreement executed in 1994 under the Indian Telegraph Act. The licence was issued under a statutory mandate and was required and acquired, before the commencement of operations or business, to establish and also to maintain and operate cellular telephone services. The licence was for initial setting up but, thereafter for maintaining and operating cellular telephone services during the term of the licence. Contrary to what was stated, under the licence agreement executed in 1994 the considerations paid and payable were with the understanding that there would be only two players who would have unfettered right to operate and provide cellular telephone service in the circle. The payment, therefore, had element of warding off competition or protecting the business from third party competition. Under the 1994 agreement, the licence was initially for 10 years extendable by one year or more at the discretion of the Government/authority. 1994 Licence was not assignable or transferable to a third party or by way of a sub-licence or in partnership.

Under the 1994 agreement, the licencee was liable to pay fixed licence fee for first 3 years. For 4th year and onwards, the licencee was liable to pay variable licence fee @ Rs.5,00,000/- per 100 subscribers or part thereof, with a specific stipulation on minimum licence fee payable for 4th to 6th year and with modified but similar stipulations from 7th year onwards. The licence could be revoked at any time on breach of the terms and conditions or in default of payment of consideration by giving 60 days' notice. The authority also reserved the right to revoke the licence in the interest of public by giving 60 days' notice. Under 1999 policy, the licencee had to forego the right of operating in the regime of limited number of operators and agreed to multiparty regime competition where additional licences could be issued without limit. There was lock in period on the present shareholding for a period of 5 years from the date of licence agreement i.e. the effective date and even transfer of shareholding directly or indirectly through subsidiary or holding company, was not permitted during this period. This had the effect of 'modifying' or clarifying the 1994 agreement, which was silent.

Licence fee calculated as a percentage of gross revenue was payable w.e.f. 1st August, 1999. This was provisionally fixed at 15% of the gross revenue of the licencee but was subject to final decision of the Government about the quantum of revenue share to be charged as licence fee after obtaining recommendation of the Telecom Regulatory Authority of India (TRAI). Failure to pay the licence fee on yearly basis would result in cancellation of licences. Therefore, to this extent licence fee was/is payable for operating and continuing operations as cellular telephone operator.

Main issue of conflict

The main issue of dispute in this matter was that the assesses i.e., Bharti Cellular Ltd., Bharti Hexacom Ltd. and Bharti Airtel Ltd. had regarded the licence fee payable under the 1994 agreement as capital expenditure. Even in case of Hutchinson Essar Pvt. Ltd., licence fee paid under 1994 policy for first three years was treated by the assessee as capital expenditure. However, in the fourth year Hutchinson Essar Pvt. Ltd. has treated the variable licence fee payable subject to minimum of @ Rs.5,00,000/- per 100 subscribers as revenue expenditure and the other assessees have treated the revenue sharing licence fee under the 1999 policy as revenue expenditure. The stands of the Revenue was that this should also have been treated as capital expenditure. The issue raised is whether the variable licence fee paid by the assessee under Indian Telegraph Act, 1885, and Indian Wireless Fee Act 1933, payable under the New Telecom Policy 1999 or 1994 agreement, is revenue expenditure or capital expenditure which is required to be amortized under Section 35ABB of the Income Tax Act.

Contentions of the Revenue

The Departmental Representative contended that the assessees who accepted and admitted that licence fee payable under the 1994 agreement was capital in nature, cannot dispute and deny the capital nature of the same payment under National Telecom Policy 1999. Even under the 1994 agreement for the 4th year, the assessee had to pay the fixed sum per 100 subscribers. The nature and character of the payment was same but amount was modified to 15% of the gross revenue under the National Telecom Policy 1999. Further, the DR contended that mere payment of an amount in installments does not convert or change the capital payment to revenue in nature. It was submitted that the criteria of once and for all payment or installment payment co-relatable to percentage of gross-turnover was not determinative of the true character of the payment. The DR argued that the true nature of the payment has to be determined on the basis of the advantage or benefit procured which in the present case relates to initial set-up of business. It was strongly contended that the right to the licence had resulted in acquisition of right to operate, and thus, it was a capital payment.

Contentions of the assessee

The counsel of the assessee contended that the licence fee payable under the National Telecom Policy 1999 was revenue in nature. It was submitted that the earnings were/are shared, and the licence fee depends upon the gross revenue and was/is payable yearly. The counsel submitted that licence by itself was not an asset or a right which could be sold. The Counsel clarified that under the National Telecom Policy, 1999 there was no limit on the number of operators and the licence granted was non-exclusive. It was clarified that new operators were issued licences and were required to pay one time licence fee for entry and start of operations in addition to yearly turnover based licence fee. It was strongly contended that the onetime payment of licence fee was capital in nature and yearly payable licence fee was not capital in nature as it was essential and an annual necessity/obligation to continue to do business. It was a running expense. The counsel for further establishing his argument submitted that the annual variable expenditure did not create or add to a profit making apparatus.

Having heard the parties, the High Court held that,

Analysis of section 3ABB

++ as is apparent from the Section itself, it applies when expenditure of capital nature was/is incurred by an assessee for acquiring a right for operating telecommunication services. It is immaterial whether the expenditure is/was incurred before or after commencing the business to operate telecommunication services. But, the payment should be actually made. We agree with the counsel for the respondents that the said provision does not stipulate or mandate that any expenditure for a right to operate telecommunication services or payment made for the said licence as per the section is deemed to be a capital expenditure. Section 35ABB is not a deeming provision but comes into operation and is effective when the expenditure itself is of a capital nature and is incurred for acquiring a right to operate telecommunication services or is made to obtain a licence for the said services. It can be incurred before commencement of business or thereafter, but should be incurred during the previous year. Thus Section 35ABB by itself does not help us in determining and deciding the question whether licence fee paid under the New Telecom Policy 1999 or under the 1994 agreement, was/is capital or revenue in nature.

Valuation of shares

++ before we examine the legal position, we would like to first deal with and examine the contention as to whether or not licence under the National Telecom Policy 1999 was transferable and the effect thereof. The licence stands issued to the company as the operator, but behind the company are the real owners i.e. the shareholders. However, a shareholder is distinct and not synonymous with company to whom the licence under the Telegraph Act, has been issued. Clause (viii) of the National Telecom Policy, 1999 permits transfer of shareholding by the shareholders directly or indirectly after lock-in period of 5 years. Therefore, it bars the licencee i.e. respondents herein from registering or recording change of shareholding pattern directly or indirectly with subsidiary company within such period. There cannot be any doubt or debate that while computing the value of the share in the hands of the shareholder, the factum and position that the respondent company has been allotted the licence was/is a relevant and important factor. However, we do not think that this can be the sound and sole basis or ground to hold that the licence in the hands of the respondent company was/is a capital asset;

+ value of a share in the hands of a shareholder may not determinatively and conclusively reflect and answer the question whether the asset held by the company was a capital asset. Market value of a share is dependent upon several factors including future prospects, nature of trade etc. These may not be an asset for the company. We cannot on this basis alone, determine and decide whether the variable licence fee paid on annual basis is capital or revenue in nature. At the same time the license was/is an important and relevant aspect that determined/determines the true market value of the respondent companies;

Rule of enduring benefit

++ at this stage, it would be appropriate to refer to relevant case law on the subject though we did not find or come across any decision of the Supreme Court or the High Court directly applicable to the factual matrix of the present cases. Starting point of discussion on the said question invariably begins with the decision of the Supreme Court in the case of Empire Jute Co. Ltd. vs. Commissioner of Income Tax. Revenue in the said case relied upon an earlier decision of the Supreme court in CIT vs. Maheshwari Devi Jute Mills Ltd., wherein sale of loom hours were held to be in nature of capital receipt and hence not taxable. The said decision was distinguished on several grounds but noticeably it was recorded that the said case had proceeded on a common accepted basis that loom hours was an asset. In Empire Jute Co. Ltd. , on deeper elucidation of relevant facts, it was noticed that there was contractual agreement restricting the right of every mill to work their looms to their full capacity as there was over capacity but low demand;

++ but this rule of enduring benefit was subject to and could break down for good reasons. The nature of advantage has to be considered in commercial sense and only when the advantage was in capital field, the expenditure could be disallowed by applying the enduring benefit test. If the advantage consisted merely facilitating trading operations or enabling the management or conduct of business more efficiently or profitably, while leaving the fixed capital untouched, the said expenditure would be on revenue account, though the advantage may endure for an indefinite period. Enduring benefit test, therefore, was not conclusive and cannot be mechanically applied without considering the commercial aspect;

Fixed and circulating capital test

++ the second test which can be applied was fixed and circulating capital test. Fixed capital being what the owner turns to profit by keeping it in his possession; circulating capital is what the assessee makes profit by parting or letting the product/asset change masters/hands. This test could be applied when the acquisition of asset clearly falls within one of the two categories but the test would breakdown where the expenditure does not fall easily within the specified category. The demarcation line between assets out of which profits were earned and the profit made upon assets or with assets, was thin and difficult to draw in several cases. The question should be judged in the context of business necessity or expediency; was the expenditure a part of assessee's working expenditure or a part of process of profit earning; whether the expenditure was necessary to acquire a right of permanent character, the possession of which was a condition for carrying on trade ?, etc;

Crux of judgments followed by High Court

++ having reproduced several judgments on the question of the decisive tests, it would be appropriate to notice one decision wherein expenditure incurred has been held to be in part capital and revenue because the tests show that expenditure incurred was for several considerations i.e. there was overlapping of capital and revenue expenditure. This aspect has been examined in detail separately below. In Jonas Woodhead and Sons (India) Ltd. vs. Commissioner of Income Tax, question arose whether 25% of the amount paid as royalty to the foreign company for technical information/ know how relating to setting up of a plant for manufacture of products was capital expenditure. Referring to the issue in question, it was observed that the answer would depend upon several factors including whether the assessee had set up a completely new plant with a new process, new technology, or the technical knowhow was for betterment of the product which was already being produced; was it a part and parcel of existing business or a new business?, Whether on expiry of period of agreement, the assessee was required to give the plans, drawings etc., or could continue to manufacture the products?, etc.;

++ at this stage, it would be relevant to clarify and elucidate the once and for all payment test. It is not necessary that once and for all payment would result in an enduring benefit nor is it a firm rule that periodical payments do not show enduring benefit. The said test has its apparent limitation, if we apply the said test without equal importance to the questions; what was acquired and why payment was made? The real and core test is whether payment (whether once and for all or in installment) was for acquisition of capital asset or rights of enduring benefit. Quantum of payment is not relevant for determining the said question as it is the nature and quality of payment and not quantum or manner of payment which is decisive. Lump-sum payment can represent revenue expenditure, if it is incurred for acquiring circulating capital though payment is made in one go and similarly payment made in installments can in fact be for acquiring a capital asset, price of which is paid for over a period of time;

+ it would be relevant here to produce the tests or principles laid down in a recent decision of this court in CIT vs. J.K. Synthetics Ltd. which are as under ;

["An overall view of the judgments of the Supreme Court, as well as of the High Courts would show that the following broad principles have been forged over the years which require to be applied to the facts of each case :

(i) the expenditure incurred towards initial outlay of business would be in the nature of capital expenditure, however, if the expenditure is incurred while the business is on going, it would have to be ascertained if the expenditure is made for acquiring or bringing into existence an asset or an advantage of an enduring benefit for the business, if that be so, it will be in the nature of capital expenditure. If the expenditure, on the other hand, is for running the business or working it with a view to produce profits it would be in the nature of revenue expenditure;

(ii) it is the aim and object of expenditure, which would determine its character and not the source and manner of its payment;…….];

Bifurcation of license fee as partly capital and partly revenue

++ having noted the aforesaid factual position, we feel that payment of licence fee was capital in part and revenue in part and it would not correct to hold that the whole fee was capital or revenue in entirety. The licencees i.e. the assessees in question required a licence in order to start or commence business as celluar telephone operator. The requirement to procure a licence or pay licence fee was a precondition before the assssee could commence or set up the business in question. The fee was certainly paid to the Government for permitting and allowing an assessee to set up/start cellular telephone service which otherwise was not permitted or prohibited under the Telegraph Act. In a way, it was a privilege granted to the assessee subject to payment and compliance with the terms and conditions;

++ there was restriction under the 1994 agreement, on transfer of the licence or even grant sub-licence but there was no specific restriction on change of shareholding. 1999 policy ensured that even shareholding did not change for a period of 5 years from the effective date. The effect of acquiring the licence has been examined in paragraph 15 above. The licence was not assignable or transferrable as such, but induction of share capital, transfer of shares etc. was permitted subject to conditions in the 1999 policy. In commercial sense the licence constituted and continues to be the most valuable right which the company has and possesses. Thus, the payment made is for acquiring the licence which is essential and mandatory, prerequisite for establishing the business and for operations or continuance and running of business. Yet, as observed below, it cannot be equated with one time entry fee which a person has to pay to establish the business. It therefore, represents composite payment, both capital and revenue;

++ the licence fee was imposed and payable under the Indian Telegraph Act and other statutory provisions and was/is mandatory. Failure to pay the same would/will result in discontinuance or stoppage of business operations. Under 1999 policy, the amount payable speaks of sharing of gross revenue earned by the service provider from the customers. 1994 agreement as noticed did have a provision for sharing but with minimum payment stipulation. In case of non-payment of licence fee, the licence could be revoked and licencee was not permitted to carry on and continue cellular telephone service. Thus, the licence fee payable was/is equally with the objective and purpose to maintain and operate cellular telephone services. It was also an operating expense and non payment can lead to cancellation as one of the consequences. Endurement requires current expenses and is subject to payment on revenue share. It will not be correct to hold or propound that entire payment during the term of licence, is deferred capital payment. This was/is not the intent under the 1994 agreement or 1999 policy. The intent is to also share the gross earning to maintain and operate the licence;

++ the licence fee as such is similar to both prospecting fee, acquisition of right to lease as well as leases which enabled removal of sand/tendu leaves, etc. as nothing has to be won over, or extracted. Part payment was towards an initial investment which an assessee had to make to establish the business. It was a precondition to setting up of business. It has element and includes payment made to acquire the 'asset' i.e. the right to establish cellular telephone service. But the licence permits and allows the assessee to maintain, operate and continue business activities. Payment of licence fee has certain ingredients and is like lease rent which is payable from time to time to be able to use the licence;

++ the licence acquired was initially for 10 years and the term was extended under the 1999 policy to 20 years but this itself does not justify treating the licence fee paid on revenue sharing basis under the 1999 policy as a capital expense made to acquire an asset. As observed in Empire Jute Co. Ltd., the enduring benefit test has limitation and cannot be mechanically applied without considering the commercial or business aspects. Practical and pragmatic view and considerations rather than juristic classification is the determinative factor. The payment of yearly licence fee on revenue sharing basis is for carrying on business as cellular telephone operator. It is a normal business expense;

++ read in this manner, the licence granted by the Government/ authority to the assessee would be a capital asset, yet at the same time, the assessee has to make payment on yearly basis on the gross revenue to continue, to be able to operate and run the business, it would also be revenue in nature. Failure to make stipulated revenue sharing payment on yearly basis would result in forfeiting the right to operate and in turn deny the assessee, right to do business with the aid of the capital asset. Non- payment will prevent and bar an assessee from providing services;

++ in Mohan Meakin Breweries Ltd. the Division Bench rightly observed that that the aforesaid passage supports the case of the assessee. Thus, we observe that the expenditure incurred for establishing or for setting up/construction of any factory/business would be capital, but the amount paid on yearly basis for running or operation of the factory/business would be normally revenue in nature;

Apportionment of license fee into capital and revenue expenditure

++ the next question or issue which arises is whether the Court can bifurcate and divide the licence fee into capital and revenue and what percentage or ratio should be attributed to revenue and capital account. It is the contention of the Revenue that the respondent assessee i.e. Bharti Cellular Ltd., Bharti Hexacom Ltd. and Bharti Airtel Ltd. had themselves treated and regarded the licence fee payable under the 1994 agreement as capital expenditure. Even in case of Hutchinson Essar Pvt. Ltd., licence fee paid under 1994 policy for first three years was treated by the assessee as capital expenditure. In the fourth year Hutchinson Essar Pvt. Ltd. has treated the variable licence fee payable subject to minimum of @ Rs.5,00,000/- per 100 subscribers as revenue expenditure and the other assessees have treated the revenue sharing licence fee under the 1999 policy as revenue expenditure. The 1999 policy has to be read alongwith original agreement but it did make a substantial dent and substantially modified the original agreement. Under the 1999 policy, the new entrants were liable to pay entry fee which was the total licence fee payable upto 31st July, 1999, and thereafter they were liable to pay the variable licence fee. Thus, the new entrants have clearly paid the "capital" entry or establishment fee and then are obliged to pay operating or maintenance fee in form of variable licence fee;

++ in Jonas Woodhead and Sons (India) Ltd., the Assessing Officer had himself treated 25% of the amount paid as royalty as capital and the balance amount was treated as revenue expenditure. Similarly in Southern Switch Gear Ltd. vs. CIT, the Supreme Court has affirmed decision of the Madras High Court in CIT vs. Southern Switch Gear Ltd., wherein royalty payable was apportioned and 25% thereof was treated as capital payment or expenditure on the ground that the right to manufacture certain goods exclusively in India should be taken as an independent right secured by the assessee from the foreign company and this right was of enduring nature. The more authoritative and lucid discussion for the purpose of the present controversy is in CIT, Madras vs. Best and Co. (Pvt.) Ltd. In the said case, the respondent assessee was carrying on business and had innumerable agencies. Compensation was received on account of cancellation of one agency and the question was whether the said compensation was capital or revenue in nature. Majority judgment answered the said question observing that compensation and loss of agencies could be both capital and revenue depending upon facts of each case and whether the cancellation had affected the earning apparatus or structure from physical, financial, commercial and administrative point of view. The answer required examination; how many agencies the assessee had; their nature, how many agencies were lost and what was the effect on the income as well as the structure of the entire business; whether the loss of agency was ordinary incident in the course of business etc. In the said case, compensation received was held to be revenue expenditure as the respondent assessee had innumerable agencies in different lines and had given up only one, to continue business in other lines. Loss of agency, it was observed, was in normal course of business and being a part of normal business, the amount received as compensation was revenue in nature. At the same time, it was accepted that the compensation paid/received was also on account of restrictive covenant for a specified period under which the assessee had undertaken not to take up competitive agency. It was observed that compensation attributable to the restrictive covenant was a capital receipt and, therefore, not taxable;

++ thus, it would be appropriate and proper to apportion the licence fee as partly revenue and partly capital;

Basis of apportionment of license fee

++ the next obvious question is, on what basis apportionment should be done and what could be the proportion of apportionment between capital and revenue expenditure. We have given due consideration to the said issue and felt that it would appropriate and proper to divide the licence fee into two periods i.e. before and after 31st July, 1999. The licence fee paid or payable for the period upto 31st July, 1999 i.e. the date set out in the 1999 policy should be treated as capital and the balance amount payable on or after the said date should be treated as revenue. There are several reasons why we have taken the said date as a cut-off point, rather than partly apportioning expenses through the entire term of the licence. These reasons are elucidated in the paragraph below;

++ licence fee was payable for establishment, maintenance and operation of cellular telephone service. Establishment and set up took place in the initial years and thereafter the payments made were/are for operation or maintaining the cellular telephone service. Initial outlay and payment, therefore, is capital in nature, whereas the outlays and payments made subsequently are to operate and maintain the service. 1999 policy in the form of letter dated 22nd July, 1999 also refers to one time entry fee which is chargeable and had to be calculated as licence fee dues payable upto 31st July, 1999 and licence fee was thereafter payable on percentage share of gross revenue. The new licences issued to others also stipulated one time entry fee and then licence fee payment on sharing basis. In view of the new 1999 policy, the earlier policy which restricted competition, underwent a change and licencees forgo their right to operate in the regime of limited number of operators. Another reason why we feel that lisence fee payable for the period on or before 31st July, 1999 should be treated as capital and the amount payable thereafter as revenue, is justified and appropriate in view of Section 35ABB. We have already quoted the said section above. The provision provides that licence fee of capital nature shall be amortized by dividing the amount by number of remainder years of licences. Thus, the capitalized amount of licence fee is to be apportioned as a deduction in the unexpired period of the licence. The provision will have ballooning effect with amortized amount substantially increasing in the later years and in the last year the entire licence fee alongwith the brought forward amortized amount would be allowed as deduction. After a particular point of time, deduction allowable under Section 35ABB would be more than the actual payment by the assessee as licence fee for the said year. This would normally happen after the mid-term of the licence period. Section 35ABB, therefore, ensures that the capital payment is duly allowed as a deduction over the term and once the expenditure is allowed, it would be revenue or tax neutral provided the tax rates remain the same during this period;

++ the effect thereof is that we are treating about 20% of the expenditure in terms of the tenure as per the 1999 Policy as capital in nature, whereas if we apply the 1994 Agreement, we would be treating about 40% of the expenditure as per the tenure as payable towards establishing or setting up of cellular business. By the time 1999 Policy was implemented in the case of the respondents-assessees, the cellular telephone business had already commenced and was in operation. The 1999 Policy had the effect of extending period of licence from 10 years to 20 years, but from the effective date. The view, we have taken, effectively means that the entire license fee paid in the initial first four years is treated as capital in nature i.e. the expenditure incurred to establish cellular telephone business, whereas the balance expenditure payable on year to year basis from 5th year onwards is treated as revenue expenditure to run and operate cellular telephone business;

++ in CIT vs. Modi Revlon (P.) Ltd., a Division Bench of this High Court observed that the tests evolved over the period have disapproved the applicability of the 'once and for all' payment and more structured approach which would take into account several factors like the licence tenure; whether licence created further rights; whether there was restriction for use of confidential information; whether benefits were transferred once and for all; whether after expiry of the licence, plans and drawings were to be returned, etc. As held and observed above, it is nature and object for which the payment is made which determines the character of payment. In the said case, it was observed that there was nothing to show or to suggest vesting of know-how in the assessee and therefore, the assessee did not derive any enduring benefit. Thus, the royalty payment was held to be revenue in nature;

Operational part of the judgment

++ in view of the aforesaid findings, the substantial question mentioned above in item Nos.1 to 9 is answered in the following manner:

(i) The expenditure incurred towards licence fee is partly revenue and partly capital. Licence fee payable upto 31st July, 1999 should be treated as capital expenditure and licence fee on revenue sharing basis after 1st August, 1999 should be treated as revenue expenditure.

(ii) Capital expenditure will qualify for deduction as per Section 35ABB of the Act.

(See 2013-TIOL-1085-HC-DEL-IT)