Interest and Penalty on License Fee – Revenue or Capital Expenditure?

1. Interest and Penalty on License Fee – Revenue or Capital Expenditure?

Background:

• Bharti Airtel, a telecom service provider, was required to pay license fees and spectrum usage charges (SUC) to the Department of Telecommunications (DoT) as per revenue-sharing terms.
• A long-standing dispute over the definition of Adjusted Gross Revenue (AGR) was resolved by the Supreme Court in favor of DoT, leading to additional liability for unpaid license fees and SUC, along with interest and penalties for delayed payment.

Taxation Issue:

• Bharti Airtel claimed these interest and penalty payments as revenue expenditure and deducted them from taxable income.
• The Principal Commissioner of Income Tax (PCIT) invoked Section 263 (revisionary jurisdiction), arguing that interest and penalties should be treated as capital expenditure, as they arose due to default in payment of a capital expense (license fee).
• The PCIT contended that the license fee itself was capital in nature, relying on the Supreme Court ruling in CIT v. Bharti Hexacom Ltd. (2023), which held that variable license fees should be amortized under Section 35ABB.

ITAT’s Decision:

• The Tribunal ruled in favor of Bharti Airtel, stating: Interest and penalty payments were compensatory in nature, not capital expenses. Unlike the license fee, which was paid for obtaining telecom rights, these penalties arose due to delayed payment and were not linked to acquiring capital assets. The license agreement did not classify interest and penalty as part of the license fee, nor did it grant additional benefits or rights. Since the expenditure was not voluntary, but rather an obligation arising from a business decision to contest the license fee, it remained a business expense. The PCIT incorrectly equated penalty/interest with license fees—while license fees may be capital in nature, interest and penalties are separate and remain revenue expenses. Thus, interest and penalty payments were deductible as revenue expenditure under Section 37(1).

2. Carry Forward and Set-off of Losses (Demerger of Tata Teleservices' Mobile Business)

Background:

• Bharti Airtel acquired Tata Teleservices Ltd.’s (TTSL) consumer wireless mobile business under a demerger scheme approved by the National Company Law Tribunal (NCLT).
• As part of this transaction, Bharti Airtel sought to carry forward and set off the accumulated losses and unabsorbed depreciation of TTSL’s mobile business under Section 72A.

Taxation Issue:

• The PCIT denied the benefit under Section 72A, arguing that: The demerger did not meet the conditions of Section 2(19AA) (which defines demerger under the Income Tax Act).Specifically, preference shares were issued instead of equity shares, violating the requirement that ? of shareholders of the demerged company should remain shareholders of the resulting company. The PCIT also claimed that not all assets and liabilities were transferred, which is a condition under Section 2(19AA).

ITAT’s Decision:

• The Tribunal ruled in favor of Bharti Airtel, stating: The demerger met all statutory conditions under Section 2(19AA).The issuance of preference shares to shareholders of the demerged company was valid under the law—there is no requirement that only equity shares be issued. All assets and liabilities of TTSL’s mobile business were properly transferred, as confirmed by financial records and NCLT approval. The PCIT misinterpreted Section 2(19AA) by assuming that preference shares do not count towards shareholder continuity. Since all legal conditions were satisfied, Bharti Airtel was entitled to carry forward and set off the accumulated losses and unabsorbed depreciation under Section 72A.

3. Taxability of Net Assets Received Under Section 56(2)(x) (Income from Other Sources)

Background:

• The PCIT attempted to tax the excess net assets received by Bharti Airtel from TTSL’s mobile business under Section 56(2)(x), which covers gifts and transfers at less than fair market value.

ITAT’s Decision:

• The Tribunal overruled the PCIT, stating: A business undertaking is not 'property' under Section 56(2)(x). The law only applies to individual assets (e.g., land, shares), not entire businesses. The Income Tax Act explicitly excludes demergers from Section 56(2)(x).The demerger was approved by NCLT and professional valuers, so there was no underpricing or unfair transaction. Section 56(2)(x) does not apply to genuine corporate restructuring like this. No deemed income or capital gain could be taxed under this provision.

4. TDS on Payments to Non-Residents (Section 40(a)(i))

Background:

• Bharti Airtel made payments for bandwidth and communication charges to non-resident entities in non-treaty countries without deducting TDS under Section 195.

PCIT’s View:

• The PCIT argued that TDS should have been deducted, and the payments should be disallowed under Section 40(a)(i).

ITAT’s Decision:

• The Tribunal ruled in favor of Bharti Airtel, stating: Payments for bandwidth and communication services are not 'royalty' or 'fees for technical services' under Indian tax law. Since these payments were not taxable in India, TDS was not required. No disallowance under Section 40(a)(i) was justified.

5. Disallowance of Expenditure Under Section 14A (Exempt Income)

Background:

• Bharti Airtel received dividends from its subsidiary, which were exempt from tax.
• The PCIT sought to disallow expenses related to this income under Section 14A.

ITAT’s Decision:

• The Tribunal ruled that no disallowance was required, because: Bharti Airtel had no other exempt income apart from the subsidiary dividend. No fresh investment was made during the year. Since the Assessing Officer had already examined the issue, the PCIT had no basis to interfere under Section 263.

Final Decision:

The ITAT ruled in favor of Bharti Airtel on all major issues, overturning the revisionary order of the PCIT. The PCIT’s attempts to deny deductions and tax additional amounts were rejected as legally untenable and excessive.

Key Takeaways from the Judgment:

? Interest and penalty on license fees are revenue expenses, not capital.

? Demerger of TTSL's mobile business met legal conditions, allowing carry-forward of losses.

? Section 56(2)(x) does not apply to demergers.

? Payments to non-residents for bandwidth are not subject to TDS.

? No Section 14A disallowance if no new exempt income or investments exist.