The understanding of Capital Expenditure and Revenue Expenditure is necessary in the finance world. The Department of Telecommunication usually deals with license fees that are categorised under these expenditures. The recent interest in this area has risen due to a ruling by the Supreme Court pertaining to Telecom Licence Fee and Amortization.
Supreme Court’s Ruling over Telecom Licence Fee
The Supreme Court (SC) has recently made a pivotal ruling regarding payment of entry fee as well as variable annual license fee made by telecommunications companies. These payments, made to the Department of Telecommunication under the New Telecom Policy of 1999, will now be considered capital expenditure and not revenue expenditure. This significant shift means that these expenses will be taxed accordingly and may be amortised in line with Section 35ABB of the Income Tax Act.
In simpler terms, instead of deducting the entire expenditure all at once, the company will need to spread out a portion of the total fee over each year for tax purposes.
Impacts of the Ruling on Telecom Companies
This paradigm shift will have impacts on the operational processes of telecom companies. One major change would be the accounting treatment of license fees. Historically, these fees have been treated as expenses, which allowed the companies claim deductions on an annual basis for tax computations.
However, the new mandate requires these fees to be considered as capital expenses, hence, these expenses must be amortised over the duration of the licence’s holding period.
Effects on Cash Flow and Financial Strain
An initial impact on cash flow is expected for telecom companies due to this change in accounting treatment. This could lead to higher EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and PBT (Profit Before Tax) but is likely to be offset over the duration of the license.
Furthermore, this ruling may exert a financial strain on companies that have incurred substantial expenses to obtain telecom licenses, especially those already experiencing financial losses.
Uncertainty About Retrospective Application
The Supreme Court’s ruling did not specify whether the new accounting framework should be retrospectively applied. This uncertainty has raised concerns within the telecom industry and brought up questions regarding tax liabilities for previous periods.
Understanding Amortization
Amortization is an accounting process employed to spread out the cost of an intangible asset or a capital expense over its useful lifespan. In more straightforward terms, it involves breaking down a large expense into smaller portions and acknowledging these portions as expenses on financial statements over a certain period. This practice presents a more accurate depiction of the asset’s impact on a company’s financial statements and tax liability over time.
Capital vs Revenue Expenditure
Capital Expenditures relate to acquiring, improving or extending long-term assets or investments expected to benefit for more than one financial year. These expenses are capitalized on the balance sheet and recognized over time via amortization or depreciation. They are subject to depreciation or amortization, leading to a delayed tax impact and often lower taxable income in the year of purchase.
On the other hand, Revenue Expenditures entail day-to-day operational expenses for maintaining and supporting existing assets or services. These are fully recognized as expenses in the year incurred on the income statement and immediately deductible from taxable income, offering an immediate reduction in tax liability.
The difference in these expenditures has an impact on a company’s profitability. While Capital Expenditure does not significantly impact short-term profitability as costs are spread over several years, Revenue Expenditure has an immediate impact on profitability, as expenses are fully recognised in the year they are incurred.
Past UPSC Civil Services Examination Questions
Understanding these expenditures is important, as illustrated by previous questions in the UPSC Civil Services Examination. For instance, a question from the Prelims 2016 asked which items are included in the capital budget of the Indian Government. Furthermore, the Mains 2021 examined the distinction between Capital Budget and Revenue Budget and required an explanation of their components.
