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?
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.
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!
 CIT v. Shyam Telelink Ltd. SLP Dairy No. 18959/2010
 CIT v. Dinesh Kumar Goel (2011) 331 ITR 10 (Del)
 Calcutta Company Ltd. v. CIT (1959) 37 ITR 1 (SC)
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