Supreme Court ruling on telcos may be a one-time hit, say analysts

Say I-T demand for shortfall in taxes for the prior period, along with applicable penalties, is likely

Treating licence fees paid by telcos as capital expenditure —in terms of the Supreme Court order — is manageable for the future even though potential dues that might have accrued in the past will be difficult to calculate, according to Morgan Stanley.

However, there could be a significant one-time impact for older telcos Bharti Airtel and Vodafone Idea if the income-tax authorities raise demand for the shortfall in taxes for the initial years, Kotak Institutional Equities said.

On Monday, the court ruled the licence fees telcos paid, despite being in annual instalments and linked to annual gross revenue (AGR), remained capital expenditure and not revenue expenditure.
 

In December 2013, the Delhi High Court (Delhi HC) had ruled that a one-time licence fee or entry fee paid before July 31, 1999, would be treated as capital expenditure and annual variable fee as revenue expenditure.

Currently telecom service providers treat licence fees as revenue expenditure and hence set them off against revenues to calculate profits. If they are treated as capital expenditure, then they would be amortised over the life of the licence (20 years) and profits would be computed accordingly.

“We note that change in treatment of licence fees paid from revenue to capital expenditure could lead to accrual of higher taxes in the initial period of the licence but potentially offset in later years through higher depreciation, depletion, and amortisation (D&A) charges,” Morgan Stanley said in a research note on Tuesday.

The potential impact on cash flows would be 2 per cent of revenues or about 4 per cent of earnings before interest, taxes, depreciation, and amortisation (EBITDA) on a gross basis in the near-term on a licence fee of 8 per cent of AGR.

“However, this would be offset by higher charges in future years of the (20-year licence) period, limiting the net impact to a much lower number. 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,” Morgan Stanley said.

However, the new tax system would result in a higher tax outgo in the initial years.

“The accounting change would lead to higher EBITDA and lower cash flow on higher tax outgo initially, but would likely even out over the license holding period. We believe the income tax authority could raise demand for the shortfall in taxes for the prior period, along with applicable penalties, which could lead to a potential significant one-time impact,” Kotak Institutional Equities said.

Kotak pointed out the latest judgment had not cleared the air on whether it would be applicable on a retrospective basis.

“However, we believe income tax authorities could raise demand for the shortfall in tax payment for the prior period, along with applicable penalties,” it said.

While officials at telecom service providers did not comment on the issue, analysts say telcos will file a review petition.