5 Expectations from Modi Budget

By Vishal Malhotra

The telecom sector has played a vital role in the growth of the Indian economy and has emerged as the prime engine of economic growth for the country, which is fortified by the Finance Minister’s targeted revenue of over Rs 45,000 crore from the sector in his maiden budget last year.

Indian telecommunications Industry has seen exponential growth (both in voice and data segment) in the recent past, evidenced by exceptional breakthrough in value added services, unprecedented proliferation of internet based applications, penetrative reach to rural areas, etc. The launch of 3G and 4G services has provided further impetus to the Industry. Besides, the Industry has also resulted in new job opportunities with the introduction of newer technologies.

However, the Industry has been seeing tough times lately with multiple tax issues surrounding it. With the new Government in charge, which has promised to bring in substantial reforms to encourage overall growth of the economy, the telecom sector, just like other infrastructural sectors, is expecting some respite in the upcoming budget, which technically would be the first full–fledged budget for the new Government.

Five issues that rank high on the wishlist of the Industry players are discussed below:

1. Amendment in ‘Royalty’ provisions

Financial Year 2012 was a landmark year in the history of Indian tax legislation when several retrospective amendments were brought by the Union Government in a single year.

One of the significant amendment was in the Royalty provisions under the Income-tax Act, 1961 (‘IT Act’) to clarify that royalty includes and has always included consideration in respect of any right, property or information, whether or not the right, property or information is used directly by the payer or is located in India or is in the control or possession of the payer. Further, an explanation was also inserted retrospectively to enlarge the scope of the term ‘process’ to include transmission by satellite, cable, optical fibre or by any other similar technology, whether or not such process is secret.

The above amendments could be interpreted to bring within its ambit payments made by telecom companies to other telecom companies for standard services like interconnect, roaming, etc., which could trigger withholding tax obligations (including payments which have already been made in the past prior to introduction of the amendments) and result in significant cash flow issues for the telecom companies.

So far as the Indian tax treaties are concerned, the term process, though included in the definition of Royalty in the treaties, has not been defined in most of the treaties. However, based on the above amendments in the domestic tax law, the tax authorities are asserting that since the term ‘process’ has not been defined in the treaties, meaning thereof should be imported from domestic law. This proposition would result in payments made to overseas operators, which are largely tax protected payments, also subject to tax withholding in India, which would make the Indian telecom companies bleed cash.

It is thus, the need of the hour that amendments should be made to the legislation to clarify that standard telecom services provided by telecom operators are excluded from the Royalty provisions under the domestic law. In addition, a specific amendment is required to clarify the supremacy of the tax treaties and that Royalty definition under the domestic law should not be imported into the tax treaties.

2. Tax withholding on margin allowed to pre-paid distributors

Telecom operators appoint independent distributors to sell telecom vouchers to the end users through retailers. These distributors are appointed on a principal to principal basis, with the ownership in the vouchers and risks/ rewards associated with the same passed on to the distributors at the time of sale of vouchers.

Given the arrangement with the distributors, margin allowed by the telecom operators, at the time of sake of vouchers, is not subjected to tax withholding. The above position is challenged by the tax authorities alleging that the distributors act as an ‘agent’ of the telecom operators and resultantly, margin allowed to them qualifies as ‘commission’ and is subject to tax withholding at the rate of 10% under section 194H of the IT Act. This has caused significant litigation and the matter is presently sub-judice before the Apex Court.

Considering the quantum involved in litigation and very low margins earned by the distributors, the Industry expects the Government to put the controversy to rest by rationalizing the provisions and prescribing a lower withholding tax rate (say 1%) on margins allowed to the distributors. It should also be specifically clarified that ‘penalty’ would not be imposed against the telecom operators for past years.

3. Implementation of Goods and Service Tax (‘GST’) regime

On the indirect tax front, one of the key demands of the Industry is faster implementation of GST, which is being seen as a significant business reform. As the Government set an aggressive target of bringing GST from April 1, 2016, it is likely that the bill shall be considered in the Budget session and certain key announcements on the roadmap for GST legislation would be made in the Budget. However, as the above is big bang reform, the Industry expects that adequate consultation shall be done with the Industry bodies and players on various issues prior to finalizing the rules for a seamless transition.

4. Reduction in Special Additional Duty (‘SAD’)

Currently, SAD of customs is an additional cost to the overall telecom infrastructure. The Industry expects the Union Government to bring in legislation to either reduce the same and make it equal to central sales tax (of 2%) or remove it altogether.

5. CENVAT Credit

Presently, multiple challenges are faced by the Industry from the perspective of availing CENVAT credit. It is expected that specific clarification be issued resolving ambiguities pertaining to availability of CENVAT credit on towers and shelters to telecom companies or other expenses, which are restricted.

Further in the previous budget, certain provisions were introduced like limitation of six months for availment of CENVAT credit of input and input services, 30% rate of interest on delayed deposit of service tax and high amounts of mandatory pre-deposit for preferring appeal. As the amounts involved are substantial and such provisions have created a compliance nightmare for the telecom players, it is expected that the Union Government would ease out these provisions and extend relief to the Industry.

The Industry keenly awaits Budget 2015 with expectations of policy changes in the tax legislation to address the concerns of the Industry players, which would go a long way in sustaining and promoting the growth of the sector.

(Vishal Malhotra is Tax Partner – Telecommunications practice at Ernst&Young. The views expressed are his personal)