India: Revenue Recognition Policy Of Telecom Companies Attains Finality

Last Updated: 13 August 2019
Article by S.R. Patnaik and Thangadurai V.P

The Indian telecommunications sector has experienced unprecedented growth in recent years due to the significant increase in the subscriber base, with an increasing percentage of them looking for pre-paid connections. The sector now reaches out to every nook and corner of the country. What is even more praiseworthy is the fact that this has been achieved at very low cost and consumers have also prospered from availing such services at one of the lowest charge-out rates.

The above was possible because Indian telecommunication players were able to come up with extremely innovative invoicing options and accordingly also adopted very different revenue recognition mechanisms. As most of the growth was seen in the pre-paid section, the revenue recognition methodology adopted by the industry was also subject to a vigorous amount of scrutiny by the tax authorities and there has been a significant amount of litigation on account of the same. The controversy primarily arose because the contracts entered into by the telecom companies with prepaid customers were large in numbers and got modified frequently.

Accounting Standard-9 issued by the Institute of Chartered Accountants of India (ICAI) dealing with 'Revenue Recognition' does not provide enough guidance in respect of the kind of complex transactions entered into by the telecom companies. In view of the same, the revenue recognition policy of the telecom companies has been questioned by the tax authorities.

It seems that the matter might have attained finality with the Supreme Court (SC) deciding on the matter in the case of Shyam Telelink Ltd.1. In the said case, the SC confirmed the order of the Delhi High Court (HC), which held that the upfront fee received by telecom companies on the sale of prepaid cards, to the extent of unutilised talk time, did not accrue as income in the year of sale. While the decision was rendered in the case of Shyam Telelink Ltd. (Assessee), it will have a significant impact on a number of similar situations. As the SC does not discuss the facts in an exhaustive manner in its order, we have taken the liberty of taking the requisite background from the HC order.

Facts of the Case

The Assessee was engaged in the business of providing basic telecom services in the state of Rajasthan and had both prepaid and postpaid subscribers. The postpaid customers were billed on the basis of actual talk time and there is no dispute regarding the year of taxability in respect of the amount received from postpaid subscribers. The dispute was in respect of the accounting treatment given to the sale of prepaid cards. The Assessee recognised the revenue on the basis of actual usage and the unutilised amount outstanding on the prepaid card at the end of the financial year, if any, was carried forward to the next year. The unutilised amount was treated as an advance in the balance sheet at the balance sheet date and was recognised as revenue as soon as either the talk time was consumed or the card lapsed on expiry of the stipulated time.

The tax authorities did not agree with the above position arguing that the Assessee should have offered the entire amount received from the prepaid subscribers as income in the year of receipt and ought not to have treated them as an advance. On further appeal, however, it was decided in favour of the Assessee, on the ground that it had the obligation to provide services in the subsequent years and, hence, the amount received in respect of subsequent years cannot be taxed in the year of receipt.

Issue Before the HC

The matter reached the HC with the following query:

Whether the ITAT erred in holding that the amount received on sale of prepaid cards to the extent unutilised talk time did not accrue as income in the year of sale?

Arguments

The tax authorities contended that the prepaid amount would be received by the Assessee at the beginning, after which it could not be claimed back by the consumers / subscribers. Therefore, the Assessee must account for and offer the entire amount received on the date of sale of the prepaid cards as income accrued to it.

The Assessee, on the other hand, relied on a number of practical and business specific issues including Indian Generally Accepted Accounting Principles (Indian GAAP). More specifically, it relied on AS-9 issued by ICAI, which dealt with the concept of revenue recognition. The said AS also stipulated that revenue from service transactions can be recognised either by proportionate completion method or by the completed service contract method. Under the proportionate completion method, revenue is recognised proportionately through the performance of each act. Whereas under the percentage completion method, revenue can be recognised as per the stage of completion of the specified contract.

The Assessee also argued that questions would arise: who would be responsible for the services to be rendered in the future if the Assessee recognises the entire revenue in the current financial year? Also, who would incur such expenses and how would that expenditure be correlated with the income that had been earned much earlier?.

In view of the above contentions, the Assessee submitted that revenue should be recognised only when the services have actually been rendered and if the services are rendered partially, only a portion of the total receipts proportionate to the degree of completion should be regarded as revenue for the relevant period.

The HC's Decision

The HC decided that appropriation of the prepaid amount was contingent upon the Assessee performing its obligation and rendering services to the prepaid customers as per the terms of the agreement. In regards to the argument of the ITD that the Assessee was not liable to repay the prepaid subscribers, the HC observed that if it fails to perform the services required to be provided by it, it would be liable to refund the advance payment received under the ordinary law of contract or under any of the more specific enactments, like the Consumer Protection Act, even if the agreement between the parties did not specifically provide for it.

The HC also took into account its own decision in the case of Dinesh Kumar Goel2, wherein the coaching institute had received the entire fee for the course spread over two years' duration at the time of admission of the students. The court held that the entire fee was not to be accounted for in the year of receipt when the payments were made, but should be spread over the entire duration of the course as per the mercantile system of accounting.

The HC also referred to the SC in Calcutta Company Ltd.3, wherein it was held that the upfront fee would be in the nature of a deposit or an advance. Otherwise, it would lead to an anomalous situation unintended under the IT Act because if the fee was received upfront, the expenses had not yet been incurred. In the absence of liability, the corresponding income should not be recognised.

The HC accordingly held that the Assessee was correct in not treating the amount attributable to unutilised talk time as income in the relevant year.

Significant Takeaways

It was not in dispute that the Assessee had to provide talk time to its subscribers till the expiry period of the card or till the complete exhaustion of the talk time. Prima facie, as per the mercantile system of accounting, income should be taxed on accrual basis. Every receipt of an amount cannot be construed as accrual of income because income is something that the taxpayer is legally entitled to appropriate to the exclusion of the payor. Therefore, so long as the obligations on the part of the Assessee are not fulfilled, the amount received from the prepaid subscribers cannot be construed as income in the hands of the Assessee.

It is also worthwhile highlighting that AS-9 has been superseded by Ind AS-115 from 2015 onwards in a phased manner. The guidance provided by Ind AS-115 is more comprehensive than the guidance provided in the AS-9. The guidance note forming part of Ind AS-115 provides that 'revenue shall be recognised when the entity satisfies the performance obligation by transferring the service to the customer'.

It also provides that in cases where the performance obligations are satisfied over time, the entity must recognise revenue overtime by measuring progress towards complete satisfaction of that performance obligation. In view of the same, as per Ind AS-115, the telecom companies shall now have to record the revenue to the extent of the services provided by them. Therefore, telecom companies, which are required to comply with Ind AS-115, need not recognise as revenue the amount attributable to services that have not yet been rendered by the telecom companies .

While the court has not significantly departed from the various precedents available on the subject, the fact that the litigation was pending before the SC means that the tax authorities have been consistently taking the view that the entire money received from the sale of a pre-paid card should be regarded as revenue during the year of receipt. As discussed above, this could create a significant amount of tax burden on taxpayers in addition to creating a significant amount of accounting mismatch between revenue and expenses. With the SC rejecting the appeal filed by the tax authorities, it is sincerely hoped and expected that the tax authorities will accept the position and depart the path of confrontation!

Footnotes

[1] CIT v. Shyam Telelink Ltd. SLP Dairy No. 18959/2010

[2] CIT v. Dinesh Kumar Goel (2011) 331 ITR 10 (Del)

[3] Calcutta Company Ltd. v. CIT (1959) 37 ITR 1 (SC)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions