“Adverse judicial outcome” for telcos raises worries about retrospective tax: Kotak Institutional Equities

Recently, the Supreme Court ruled that the licence fee is a capital expenditure and not a revenue expenditure

The telecom sector has faced another adverse judicial outcome, which could lead to the companies reporting higher operating profit and Profit Before Tax (PBT) but lower cash flow in the near term, according to analysts at Kotak Institutional Equities.

While this negative impact may even out over the long term, there may be a bigger worry in terms of retrospective tax claims, according to the report by the brokerage, which holds “Attractive” as a sector view.

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"The SC ruled that the license fee telcos pay, despite being in annual instalments and linked to annual revenue (AGR), remains a capital expenditure and not a revenue expenditure. In December 2013, the Delhi High Court ruled that a one-time license fee or entry fee paid before July 31, 1999, would be treated as capital expenditure and annual variable fee as revenue expenditure,” said the brokerage’s report.

“The SC judgment set aside the Delhi HC’s earlier order, noting that the migration to the 1999 telecom policy (from 1994 policy) and variable nature of payments, does not change the license fee’s essence,” it added.

This will lead to a higher tax outgo, though the tax outgo would reduce over the years and average out as what it is now, according to the analysts.

“Currently, telcos account license fees as an expense and hence, was tax deductible. However, after the SC judgment, the license fee (similar to spectrum instalments) would become a capital expenditure and lead to a bump-up in reported EBITDA/PBT and higher tax outgo in the initial years. We believe that the tax outgo would decline in later years, as amortization benefits accumulate and overall tax outgo would remain broadly similar over the license period,” the analysts wrote.

But the bigger worry, according to the report, would be if income-tax authorities raise demand for the shortfall in tax payment for the prior period, along with penalties.

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“For telcos, which have completed the initial 20 years of the license, the past tax shortfall would likely pertain only to the difference in payment timings and change in the tax rate, in our view. However, there could be a significant impact of the tax shortfall if 1) the telco is still to complete the initial 20-year license period or 2) for the period after license renewal,” the analysts wrote.

That said, they wrote that they have not incorporated potential tax liabilities for telcos in their model and are awaiting further clarity on the actual amount and potential penalties (if any). They also believe that telcos are likely to file a review/curative petition in this case and the actual tax liability (if any) could get delayed.

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