The classification of business expenditure as being either revenue or capital in nature has been a longstanding issue of dispute before the Courts. Correct classification is necessary from an income-tax perspective because of the different tax treatment afforded to both the expenditures under the IT Act. For reference, revenue expenditure is allowed as a deduction under Section 37 of the IT Act, provided it does not fall within the ambit of depreciation, or any other exceptions as envisaged under Section(s) 30-36 of the IT Act. The SC, recently, in Commissioner of Income-tax, Delhi v. Bharti Hexacom Ltd.^[1], has decided the issue of characterisation of telecom license fee in favour of the revenue to deem it as capital expenditure. By virtue of the said decision, it has thus reversed the earlier decision delivered by the Delhi HC.

The Department of Telecom (‘DoT’) of the Government of India, by way of the powers granted to it under Section 4 of the Telegraph Act, 1885, introduced the Telecom License Policy of 1994 (‘Policy of 1994’). The Policy of 1994 allowed telecom operators to obtain licenses to “establish, maintain and operate” its services for 10 years, subject to payment of a fixed license fee for three years followed by an annual variable fee. Failure to pay would result in revocation of license. Subsequently, the DoT proposed a shift to a new regime by way of the introduction of the Telecom License Policy of 1999 (‘Policy of 1999’). Through the Policy of 1999, the licensees to operate, were required to pay a onetime license fee followed by a variable license fee i.e., being 15% of the Annual Gross Revenue (‘AGR’).

The issue that whether the license fee constitutes revenue or capital expenditure, arose first before the Delhi HC where it was held to partake the character of both revenue and capital expenditure. Whilst noting the complexities of the sui generis issue, it was ultimately held by the Delhi HC that license fee paid initially for establishment, maintenance and operation of cellular telephone service was capital in nature while the “outlays and payments” made on a yearly basis was revenue in nature since it was an expense to operate the business rather than to establish it.^[2] The Delhi HC was further guided by the dictum of the SC^[3] which held that “practical and pragmatic view and considerations rather than juristic classification” is the determinative factor in deciding issues of classification.

The SC, on an appeal by the revenue, has reversed the decision of the Delhi HC to hold that payment of license fee including the variable license fee is capital expenditure in its entirety. The SC, in its decision, has held that payment of the variable fees represents payment of the original obligation for acquiring the capital asset (right to set up telecom operations), the price of which is paid over the period of the license. Further, the fact that payments are made in installments does not convert a capital expenditure into a revenue expenditure. Thus, the material nature of right sought to be secured through the transaction ought to guide the categorisation of expenditure rather than structure or schedule of payment.

In this regard, the SC relied heavily upon its earlier decision in the Pingle Industries Ltd. v. Commission of Income-tax^[4], where periodic payments to secure the right to operate a lease were held to be in furtherance of acquisition of the right to operate and thus the expenditure was held to be capital in nature. It further held that the Delhi HC had artificially bifurcated the nature of payment and that the lump sum payment along with AGR payment constituted a single source of payment. The SC also distinguished the decisions of the SC relied upon by the Delhi HC.

Thus, by virtue of the verdict, the AGRs paid would necessarily have to be computed under the aegis of Section 35ABB of the IT Act which allows for amortisation of such expense for telecom operators.

[1] Commissioner of Income-tax, Delhi v. Bharti Hexacom Ltd., 2023 INSC 917 (SC).

[2] Para 43, Commissioner of Income-tax v. Bharti Hexacom Ltd., [2019] 417 ITR 250 (Delhi HC).

[3] Empire Jute Co. Ltd. v. Commissioner of Income-tax, [1980] 124 ITR 1 (SC).

[4] Pingle Industries Ltd. v. Commissioner of Income-tax, [1960] 40 ITR 67 (SC).