Himanshu SinhaPartner
Aditi GoyalCounsel
Aishwarya PalanSenior Associate
Key Developments
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Supreme Court holds the issuance of notification necessary for invoking the most favoured nation clause of tax treaties
In a landmark decision in the case of Assessing Office v Nestle, the Supreme Court, ruling in favour of the tax authorities, held that a notification by the government is mandatory for claiming the benefit of the most favoured nation (MFN) clause of a tax treaty. The Supreme Court also held that the benefits of the MFN clause can only be claimed based on a treaty entered into with a country that was already a member of the Organisation for Economic Cooperation and Development (OECD) at the time of signing of the tax treaty, and not if the country became a member of the OECD subsequently (i.e., after the signing of the tax treaty).
While review petitions have reportedly been filed against the decision of the Court, taxpayers will need to carefully evaluate the ramifications of this ruling if they have obtained the benefit of the MFN clause in the past.
(To read our detailed analysis of this decision, click here.)
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Supreme Court holds annual telecom license fee to be an amortisable capital expenditure and not a revenue expenditure
In another significant decision in C.I.T. Delhi v Bharti Hexacom Ltd. and Ors., the Supreme Court ruled in favour of the tax authorities and held that the license fee paid to the department of telecom towards the right to establish, operate and maintain telecom services is a capital expenditure. It further held that such payment can be amortised in accordance with the provisions of the Income-tax Act, 1961 (ITA) in terms of which a tax deduction can be claimed over the license period. In doing so, the Court considered a plethora of decisions and enunciated broad principles to enable taxpayers to determine whether an expense should be categorised as capital or revenue in nature.
The subject matter of the dispute was centred around the National Telecom Policy of 1994 (1994 Policy) which allowed telecom operators to obtain licenses to 'establish, maintain and operate' telecom services for a prescribed period for payment of a fixed license fee followed by an annual variable fee. Subsequently, the 1994 Policy was replaced by the New Telecom Policy, 1999 under which telecom operators were required to pay a one-time entry fee and a variable license fee based on a percentage of their annual gross revenue.
A question arose as to whether the license fee qualifies as capital expenditure or revenue expenditure under the provisions of the ITA. The taxpayer treated the license fee as tax-deductible revenue expenditure on the basis that such fee was paid on a revenue sharing basis. However, the tax authorities rejected this claim and categorised the license fee as capital expenditure instead. The issue travelled to the Delhi High Court, which held the licence fee to be partly revenue and partly capital in nature. Specifically, the High Court treated the license fee paid initially to 'establish, maintain and operate' telecom services as capital expenditure and the license fee paid yearly thereafter as revenue expenditure (on the basis that such payments were made to operate the business, and not establish it).
Aggrieved, the tax authorities appealed against the decision of the High Court. In its ruling, the Supreme Court held that the license fee cannot be apportioned into capital and revenue expenditure and categorised it as amortisable capital expenditure citing the following reasons:
- The license fee under consideration was not paid for divisible rights that warranted divisible payments. Therefore, apportioning the payment of license fee for an indivisible right into capital and revenue expense was without any legal basis. Further, the mere payment of the fee in a staggered or deferred manner cannot alter the nature of payment.
- Failure to pay the licence fee would lead to revocation and cancellation of the licence. This asserts the legal position that such annual license fee was paid towards the right to operate telecom services and would, therefore, qualify as a capital expenditure.
- The nature of periodic payments would be distinct from lumpsum payments only when the periodic payments do not have a nexus with the original obligation. In the facts of this case, the successive period instalments as well as the one-time fee, both related to the same obligation, i.e., consideration for the right to establish, maintain and operate telecom services.
- Lastly, the right conveyed by the license was a composite right and could not be bifurcated into the right to establish telecommunication services on one hand and the right to maintain and operate telecommunication services on the other.
Considering the above, the Supreme Court held that a payment which is intrinsic to the existence of the licence, as well as trade itself, should be characterised as capital expenditure. Accordingly, the one-time entry fee as well as the variable annual fee were held to be capital in nature.
This ruling overrides the decision of the Delhi High Court and several other decisions that followed the decision of the High Court. Further, this decision is expected to not only impact the telecom industry (as players in the telecom industry will need to reconsider the impact of the payments classified as revenue expenditure) but also other sectors employing similar operating models involving the grant of 'rights', such as mining, aviation, oil and gas sectors. While review petitions have reportedly been filed against the decision of the Court, going forward, a thorough analysis of the facts, contractual arrangements, and related policies would be apposite before ascertaining the nature of expense as capital or revenue.
