Tax Bottlenecks for Telecom in India
Voice & Data Magazine
Tax Partner - Telecom Practice, EY
Indian telecommunication industry is a growth centric, continuously evolving business sector that has witnessed incredible expansion in the recent past. India being a uniquely diversified market with a rich demographic dividend, currently housing world’s second largest telecom subscriber base. The number of telephone subscribers in India was around 933.00 million at the end of March 2014, according to a recent TRAI report.
Recent technological advancements have resulted in exceptional breakthrough in value added services. This has resulted in opening up of newer revenue churning avenues viz. mobile banking, unprecedented proliferation of internet-based applications ranging from social media, gaming applications to e-commerce, etc. The launch of 3G and 4G has further set the buck spinning in favour of the telecom industry. Such momentous growth is not unconditional and the industry is bearing pressures like security challenges, providing consistent broadband connectivity, and facilitating capital infusion among others. Adding to the struggle, several existing tax provisions are exerting additional burden on the industry that need not only require a thorough review but also need complete revamping in few cases. Efficient policy changes, coupled with effective implementation is need of the hour and plays a pivotal role in sustaining and promoting growth in this sector. With Union Budget 2014 being the first budget under the new government, all stakeholders ardently await the offerings in store for the sector. We have summarized hereunder a few key challenges faced by telecom sector that require attention of policy makers:
Key Direct Tax Issues:
1) Retrospective amendments
Financial year 2012 is a landmark year in Indian taxation history and none of the Indian tax practitioners can afford to ignore Finance Act (FA) 2012, that’s better known for introducing several retrospective amendments in a single year by the Union government. Generally, a retrospective amendment is not considered substantive in nature if rationale behind its insertion entails providing clarification on existing provision in the statute. However, few of such retrospective amendments have adversely impacted telecom companies and same are discussed as under:
Retrospective expansion to tax ‘indirect transfers’
FA 2012 has introduced retrospective amendments to tax gains accruing on transfer of shares of foreign entity if it derives its value substantially from assets located in India. Introducing such an amendment with retrospective effect not only increases the tax burden but also promotes uncertainties regarding withholding tax obligations, which are impossible to comply for past periods. Therefore, such amendments should be made prospective and key terms like ‘substantially’ should be defined to remove any ambiguity.
Retrospective expansion in definition of Royalty
In addition to above, retrospective amendments have also been made to enlarge the scope of royalty definition. Such amendments could be interpreted to include payment for standardized telecom services under its ambit. However, it does not appear to be the intention of amendments. Therefore, such provisions should be amended to exclude such standardised services from its ambit.
Further, these amendments impose an obligation to withhold tax from payments which have already been made in past, therefore, resulting in impossibility of compliance with withholding tax compliances for earlier periods. In many cases, telecom operators would not be able to recover such taxes from the recipients (especially in case of non-residents) and would have to bear such additional cost. Therefore, making such amendments prospectively applicable would come as a major relief to the sector. Also, the definition of Royalty should be amended to exclude from its ambit payments for standard telecom services. Specific amendment should also be brought in to clarify supremacy of the term “Royalty” as contained in Double Taxation Avoidance Agreements.
Anti-abuse through transfer pricing provisions
Transfer Pricing provisions were introduced in 2001 as a part of anti-tax avoidance regulations. In FY 2012, an explanation to the definition of international transaction has been retrospectively introduced to clarify provisions incorporated in 2001. By virtue of such amendment, transactions like capital financing, guarantee, business restructuring etc., have been covered under the definition of international transaction and hence have been subjected to transfer pricing provisions. In view of such amendments, tax authorities have attempted to scrutinize past transactions of telecom service providers. Such action would not only treat otherwise compliant tax-payers as non-compliant but would also result in imposing penal consequences, leading to further litigation. Therefore, it is important that Budget 2014 removes the retrospective applicability of such substantive anti-avoidance provisions.
2) Withholding tax woes
Telecom operators avail diverse services from telecom infrastructure service providers, distributors, connectivity providers, etc. Lack of clarity in applicability of withholding tax provisions on such services leads to significant litigation by the telecom service providers. Few of such challenges are iterated below:
Services availed from telecom infrastructure service providers
Telecom infrastructure companies facilitate telecom services through provision of infrastructure support services such as providing access to common towers, continuous power supply, air-conditioning, etc. Such services are not specifically covered under any of the existing withholding tax provisions and hence, such services are subjected to different rates of withholding tax which adds to the ambiguity. Therefore, clarity is required on the applicability of withholding tax provisions on payments made for such infrastructure services.
Prepaid vouchers sold by distributors
Telecom operators appoint independent distributors to sell SIM cards and telecom vouchers to the end users through retailers. Operators take position that discount offered to the distributors do not qualify as ‘commission’ and hence, it should not be subjected to withholding tax. However, revenue authorities have adopted a contrary position that tax withholding is required on margin earned by distributors as relationship between operator and distributor is of principal and agent. This matter is presently pending adjudication before the Supreme Court of India.
A withholding tax rate of 10% is being imposed on discounts extended to the distributors by treating the same as a “commission” under section 194H. Given the quantum involved and the litigation on this issue, it is high time this issue is addressed by rationalizing the withholding tax rate/provisions or bringing necessary clarifications to this effect. Considering the lower margins earned by the distributors, a lower withholding tax rate of 1% may be prescribed for telecom distributorship services, irrespective of the nature of the underlying arrangement between the telecom operators and the distributors.
3) Issues surrounding spectrum fees
Spectrum is a quintessential ingredient to provide telecom services. Multi-crore payments are made by telecom companies to acquire such spectrum rights. Presently, there is no specific provision on tax treatment of such cost incurred by telecom companies. Revenue authorities advocate that such expenditure should be amortized over the effective license period. On the other hand, telecom companies categorize spectrum as an intangible asset and claim depreciation thereon. A specific clarification is necessary for encouraging uniform tax practices among taxpayers.