India Inc must brace for unexpected tax demands

The recent ruling on telecom fees as capital expenditure shakes the industry, highlighting corporate boards’ tax interpretation challenges.

The recent ruling of the Supreme Court treating entry fees and the variable annual fees under the Telecom Policy of 1999 as capital expenditure to be amortised over a period, as against partly capital and partly revenue as claimed by the telecom players, has come as a bolt from the blue.

This decision is going to hit the industry hard, which is already reeling under severe business pressure and huge losses. The purpose here is to highlight the uncertainty and nebulous nature of tax positions that corporate boards have to deal with rather than discuss the merits of the order.

Lately, GST show-cause notices and demands — Dabur India ₹321 crore and ICICI Lombard ₹1,730 crore, to name a few — have been hogging newspaper headlines. Also, there is a report that DGGI has detected ₹1.36-lakh crore of GST evasion so far in FY 23-24.

In the telecom case under question, the company had won the matter in the Delhi High Court, but the Supreme Court reversed the order. The demands once raised will mostly hit the profit and loss account since no provision would have been made in the accounts. How will a director on the board deal with risks associated with tax interpretations? The natural process is to get multiple legal opinions just to ensure that the company is on the right track. Are legal opinions akin to insurance policies? The answer, based on tax demands on Vodafone of ₹22,100 crore in 2007 and Cognizant of ₹3,300 crore in 2023, is an emphatic ‘no’. While they do serve as a comfort factor to the board, the ultimate test of success lies in the decision of the courts.

The time has come for boards to take strategic and risk mitigating calls on tax interpretation issues. The simple reason being in high stakes matters, the buck starts and stops with the board.

Aggressive tax positions have to be viewed in the context of what could be the final outcome and the reputation damage such demands can cause to the otherwise blemish less track record of the company. The days of merely leaning on legal opinions are now a thing of the past.

Contingent liabilities

Various tax demands raised in the past are disclosed as contingent liabilities not provided for in the financial statements. In some cases, these amounts are staggering and disproportionate to the net worth of the company. There are cases under contingent liabilities that have made no progress at all for years. These could potentially explode as demands in one year, and virtually decimate the financials of that year. Time has come to seriously consider a portion of tax related contingent liabilities as designated provisions on a systematic basis. This could be called ‘Tax Contingency Reserve’.

The amounts can serve as a cushion to absorb sudden shocks by way of demands. Better still the amounts can be invested in income-yielding securities to be liquidated only for this purpose. What better risk-mitigation measures than keeping cash ready for a rainy day when there is an unforeseen tax demand? Further, it would be appropriate to peg tax related contingent liabilities at, say, 50 per cent of net worth. If the amount exceeds this limit, it should be red flagged, warranting serious and detailed discussions at the risk management committee of the board.

An ideal and durable solution would be a speedy and effective Advance Ruling mechanism. But that is a separate subject for discussion.

Written by R. Anand. The writer is a chartered accountant.

Views are personal and do not represent the stand of this publication.