The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has held that Capital Work-in-Progress (CWIP) accounting does not determine tax character of operational expenditure.
The bench of Amit Shukla (Judicial Member) and Arun Khodpia (Accountant Member)has dismissed both Revenue appeals in the case of Reliance Jio Infocomm Limited for Assessment Year 2019-20, delivering significant findings on two recurring income-tax issues: whether operational expenditure capitalised as Capital Work-in-Progress (CWIP) can nevertheless be claimed as revenue expenditure, and whether payments to non-resident telecom operators for voice termination, bandwidth and operation and maintenance services attract withholding tax as royalty or fees for technical services (FTS).
The first appeal concerned a massive disallowance of ₹1,10,03,17,60,701, representing operational expenditure which had been capitalised in the company’s books under CWIP but was claimed as revenue expenditure while computing taxable income.
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The core legal question before the Tribunal was whether the fact that expenditure was shown as CWIP in the financial statements automatically made it capital expenditure for income-tax purposes, or whether the expenditure had to be examined independently on the basis of its actual nature and purpose.
The Tribunal noted that the telecom business had already commenced commercial operations in FY 2016-17. During the relevant year, the company had an extensive operational network, approximately 306.7 million subscribers and operational revenue of around ₹38,838 crore.
The expenditure in dispute included interconnect charges, employee costs, professional fees, call-centre expenses, power and fuel, repairs and maintenance, network costs, interest, selling and distribution expenses, customer-service expenses, bank charges, rates and taxes, ILL expenses and travelling expenditure.
The company maintained that these were recurring costs incurred in operating an already established telecom business and did not themselves result in the creation of a new capital asset.
The Tribunal examined the accounting policy under which network assets were capitalised when they became available for use and were working in the manner intended by management.
The company had prescribed various Quality of Service (QoS) parameters. Where network infrastructure had achieved the prescribed parameters, corresponding operational expenditure was charged to the Profit and Loss Account. Where infrastructure had already been installed and put to use but had not yet achieved the specified QoS benchmarks, related operational and indirect expenditure continued to be reflected in CWIP.
The Tribunal found that this accounting methodology did not necessarily mean that the underlying expenditure was capital in its intrinsic character.
The distinction between accounting recognition and tax deductibility was therefore central to the decision.
The Tribunal categorically held that accounting treatment is a relevant consideration but cannot substitute the statutory test under the Income-tax Act.
According to the Tribunal, the question whether an expenditure is capital or revenue must ultimately be determined by examining what the expenditure was incurred for and what it brought about in the commercial framework of the business.
The Tribunal relied upon Supreme Court decisions including Kedarnath Jute Mfg. Co. Ltd. v. CIT and Taparia Tools Ltd. v. JCIT for the principle that entries in the books are not conclusive for determining tax liability or deductibility.
The Tribunal further observed that telecom infrastructure necessarily requires continuous optimisation, maintenance, strengthening and improvement even after commercial operations have commenced. Merely because expenditure is connected with improvement of an existing network does not automatically make it capital expenditure.
The decisive consideration is whether the particular expenditure creates a new asset, enlarges the fixed profit-making apparatus, or instead represents expenditure incurred for operating and efficiently exploiting an existing business apparatus.
A significant factor was that the Assessing Officer had not undertaken a head-wise examination demonstrating that the disputed operational expenses resulted in acquisition or creation of identifiable capital assets.
The Tribunal noted that actual expenditure incurred for acquiring and constructing telecom assets such as antennas, fibre, routers, batteries, generators and electronic equipment had separately been capitalised, including for income-tax purposes.
The dispute was confined to the indirect and recurring operating expenditure that had been allocated to CWIP under the company’s accounting policy.
The Tribunal found that the Revenue’s approach of treating the entire ₹1,100 crore-plus amount as capital expenditure merely because it was carried in CWIP and was connected with network improvement was insufficient to establish its capital character.
The Tribunal also relied heavily on its earlier decision for AY 2018-19, where substantially identical operational expenditure had been held allowable under Section 37(1), notwithstanding its capitalisation in the books.
The earlier decision involved expenses such as interconnect charges, employee costs, professional fees, call-centre expenses, power and fuel, repairs and maintenance, network costs, interest, selling and distribution expenses and customer-service expenses.
The Tribunal noted that the Revenue had not demonstrated in the earlier proceedings how these day-to-day operating expenses resulted in asset upgradation or an enduring capital benefit.
Finding no material change in facts or law, the Tribunal followed the earlier view and upheld the CIT(A)’s deletion of the ₹1,10,03,17,60,701 disallowance.
The second department appeal involved a separate disallowance of ₹66,65,41,174 under Section 40(a)(i).
The Assessing Officer had alleged that payments made to non-resident telecom operators towards voice termination services, bandwidth services and operation and maintenance services were taxable in India as royalty and/or FTS.
Consequently, according to the Revenue, the company was required to deduct tax at source under Section 195. Since tax had not been deducted, the corresponding expenditure was disallowed under Section 40(a)(i).
The payments covered voice termination services of approximately ₹42.10 crore, bandwidth services of approximately ₹15.48 crore and annual operation and maintenance services of approximately ₹9.07 crore, aggregating to about ₹66.65 crore.
The department argued that voice termination and bandwidth services necessarily involve sophisticated telecom networks, technical processes and equipment and that consideration paid for using such infrastructure should be treated as royalty.
The assessee, however, contended that it merely received standard telecom services. It did not acquire ownership, possession or control of the foreign operators’ network or equipment, nor was any technical process or know-how made available to it.
The Tribunal accepted the distinction between using a technology-enabled service and using or acquiring a right to use the technology, process or equipment itself.
It observed that the fact that a service is technologically sophisticated does not, by itself, mean that the customer has acquired a right to use the underlying technology or equipment.
The Tribunal found that the foreign telecom operators retained control over their own networks and technical infrastructure.
The assessee delivered traffic at agreed interconnection points and received the contracted connectivity or termination service. The underlying technological processes remained embedded within the service providers’ own networks.
The Tribunal emphasised that there is a material legal distinction between receiving the result of a technological process and acquiring a right to use the process itself. The mere fact that sophisticated technology is indispensable for providing a service does not transform the consideration for that service into royalty.
The Tribunal also considered the Revenue’s reliance on the wider domestic-law definition of royalty.
It referred to the principles emerging from DIT v. New Skies Satellite BV and the Supreme Court’s decision in Engineering Analysis Centre of Excellence (P.) Ltd. v. CIT.
The Tribunal observed that a subsequent unilateral amendment to domestic law cannot automatically be imported into an existing Double Taxation Avoidance Agreement (DTAA) where the treaty itself has not been correspondingly amended.
Thus, where the treaty provides more beneficial treatment, the treaty provisions can prevail by virtue of Section 90(2).
On the issue of operation and maintenance services, the Tribunal noted that the services were performed to keep the foreign operator’s infrastructure functional.
There was no transfer of technical knowledge or capability enabling the assessee to independently perform the maintenance activity.
The Tribunal therefore found no basis to characterise the O&M payments as FTS merely because technical expertise was employed by the service provider.
The Tribunal stressed that the relevant question is not whether technology or technical expertise is involved somewhere in the service delivery, but whether the payer obtains the technology, process, equipment or technical capability in the manner contemplated by the applicable treaty provisions.
Once the payments were held not to constitute royalty or FTS/FIS under the applicable treaty provisions, the Tribunal treated the receipts in the hands of the foreign telecom operators as business profits.
The Tribunal noted that there was no finding that the concerned non-resident telecom operators had a Permanent Establishment (PE) in India to which the receipts could be attributed.
Accordingly, under Article 7 of the applicable DTAAs, the business profits could not be taxed in India in the absence of a PE. Since the payments were not chargeable to tax in India, the Tribunal found that no withholding obligation under Section 195 arose and, consequently, Section 40(a)(i) could not be invoked.
The Tribunal also took note of earlier decisions concerning substantially similar telecom arrangements.
The record referred to earlier rulings concerning bandwidth services, voice termination and O&M services in which the payments or corresponding receipts had been held not to constitute royalty or FTS under the relevant DTAAs.
The Tribunal also noted earlier decisions concerning the recipient entities themselves, where receipts from voice termination, bandwidth and O&M services had been treated as business profits rather than taxable royalty or FTS.
The assessee had also filed an application under Rule 27 of the Income-tax (Appellate Tribunal) Rules, 1963, seeking to support the CIT(A)’s order on the additional ground that the reassessment proceedings themselves were invalid.
However, since the Tribunal dismissed the Revenue’s appeal on the substantive issue of Section 40(a)(i), it found it unnecessary to adjudicate the Rule 27 grounds. The legal contentions concerning validity of reopening were therefore left open.
Ultimately, the Mumbai ITAT found no basis to interfere with the CIT(A)’s orders on either issue.
The tribunal upheld the deletion of the ₹1,10,03,17,60,701 disallowance relating to operational expenditure capitalised as CWIP and also upheld deletion of the ₹66,65,41,174 disallowance under Section 40(a)(i) relating to payments to non-resident telecom operators.
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