The Proposed Finance Bill 2016 can Potentially Damage ‘Digital India’ campaign

Telecom service is designated as an essential service under the Essential Services Maintenance Act, 1968, and also evidently a key infrastructure essential to ensure growth. The Government vide the Finance Bill 2016 has proposed a tax framework that will be punitive and unfair to the telecom sector.  The proposals will directly impact the common man on account of higher prices and essential funds being diverted to taxes instead of being invested in essential infrastructure.

Key proposals:

Assignment of spectrum and subsequent transfer thereof is proposed to be declared as a services under Section 66E of the Finance Act, 1994

All Government services have been made liable to service tax and to be paid by the recipient on a reverse charge basis with effect from 1 April 2016.

Cenvat Credit of the tax so imposed on such assignment is proposed to be deferred over the life of the license period.

Government services provided as sovereign functions should not be taxable

The Government has stated that the assignment of right to use spectrum by the Government and its subsequent transfer is a service under Section 66E and is leviable to Service tax and. World over it is a prevalent practice to segregate sovereign functions form other commercial transactions of the Government for taxation purpose, wherein, sovereign functions of the government are not subjected to any tax.  Government assigns spectrum to enable telecom operators to provide essential telecom services. Assignment of spectrum, a scarce natural resource, is an important sovereign function of the Government, and treating such activity as ‘service’ liable to service tax at par with normal commercial transactions is a deviation from the standard practices adopted across the world by other jurisdictions.

Levy on past assignments of spectrum is a case of retrospective taxation

Section 66B of the Finance Act, 1994 provides for a levy of Service tax not only services provided but also services agreed to be provided. In view of this provision there can’t be any Service tax on spectrum that stood assigned or agreed to be transferred on or before 31 March 2016. Assignments or transfers executed prior to the enactment should not be liable to Service tax. If the government seeks to tax such previous assignments, it would be a classic example of retrospective taxation. Such changes in the commercial understanding hugely increases uncertainty for operators. A specific clarification that payments of instalments related to past spectrum assignments made on or after the enactment should not be liable to Service tax shall remove ambiguity and needless litigation.

Recurring license fee and spectrum usage charges should be excluded from the scope of Service Tax

Given the wide definition of ‘service’, and the amendment proposed, there may be dispute whether permitting a telecom service provider to provide telecommunication services qualifies as service by the Government and therefore subject to levy service tax. Service tax on a regulatory levy (i.e. license fee paid to the Government) will evidently result in double taxation and trigger a substantial increase in cost.

Deferral of tax credit pertaining to Service tax paid on assignments results in cascading of taxes ultimately resulting in credit denial

The proposal of deferral of input tax credits over the assignment period is unprecedented.

The government has never sought to align credit availability to the life of an asset or the period of benefit accrued precisely for the reason that any such deferral means effective denial of credits as the net present value of deferred credit availment diminishes significantly when credit is deferred for such large period.

Even for procurements that are similar where benefits are accrued over a period of time such as financial leases, licensing of patents/ other IPRs input credit is available immediately. Singling the assignment of spectrum, by deferral of input credit seems unfairly punitive and will materially hurt the financial health of the industry.

Credits of service tax imposed in respect of received services are available immediately on receipt of invoice or payments for services.  Even in case of capital goods, benefit of credit is available within an average period of six months (over two financial years).

The proposed deferral of credits over the license period, will mean that credits availment will be stretched over 20 years.  The deferral effectively results loss in the range of 61 to 71 percent of the Service tax payable on the assignments by the government.

The proposal will undo the Government tax reform programme of ensuring mitigation of cascading effect of taxes on account of credit blockages.

Tax is an additional burden and will have impact on health of the industry

It needs to be appreciated that the service tax levy on spectrum assignment means that during auctions lined up for June-July, where reserve price is around Rs. 5.36 lakh crores, the industry will have to cough up minimum Rs. 77,000 crores as service tax. This is a substantial financial burden on the industry which is reeling under debt. Further deferral of credits will mean that the industry will be burdened by minimum  effective cost of Rs 40 – 50,000 crores.  The Government’s tax estimates from Service Tax for 16-17 do not anticipate revenue collection to this extent.

It may be noted that the industry has seen an unprecedented increase in cost of spectrum, where in the administered spectrum regime, the cost of spectrum accounted for about 10% of gross fixed assets, but with spectrum now being auctioned, the figure has gone to over 50% of gross fixed assets. Also, it is worth noting that what is meant to be a “zero cost” in the cenvat credit system for any operator who has adequate output Service tax, will convert up to a 71% cost of the tax imposed. The cost on account of deferral of credit would severely impact the health of the telecom industry. If the costs were to be passed on to the end consumer, it would not only result in a significant increase in the cost of telephone services, but also have an adverse impact on the Digital India initiative, as well as, the financial inclusion plan of the Government. Mobile telecom service is the backbone for these initiatives and such a heavy burden on the operators would cause undue hardship to the operators.

Conclusion

Considering the substantial tax impact on an essential service such as the telecom service it is imperative that the government reconsiders the service tax proposals in view of the direct impact on the aam aadmi as also the adverse impact on the Digital India initiative.

Income Tax   

The new proposals in the Income Tax act on deductions related to assignments may be mis- interpreted

The mis-interpretation may lead to incorrect deferral of deduction for spectrum amounts. .

Clarifications are essential to ensure treatment under the Income Tax act is consistent in all cases.

Finance Bill 2016, proposes to insert Section 35 ABA in the Income tax Act, 1961 (the Act).  The said section prescribes that a deduction from income would be granted of an appropriate fraction of the expenditure incurred on acquiring the right to use spectrum and for which payment has actually been made.

A telecom operator bidding for spectrum can upfront pay for the spectrum acquired. The Government also has a facility whereby the acquisition bid amount can be paid in instalments over a prescribed period alongwith prescribed interest. This instalment facility is given primarily to mitigate the financial burden on telecom operators who are already reeling under a large debt burden.

Section 35ABA of the Act, can be mis-interpreted that deduction is to be allowed (from taxable income), only of an appropriate fraction of instalments paid and not of the actual bid amount incurred while acquisition of the spectrum.   Such an interpretation will lead to penalising telecom operators who opt for instalment schemes by deferring deduction vis a vis where bid amounts are paid upfront to the government.  Evidently the Government could not have intended this.

To mitigate ambiguity that could result in fruitless litigation and increased uncertainty, it is essential that appropriate clarifications are issued ensuring that deductions are granted of an appropriate fraction of the bid amount in all cases.