Safiya Malik

The Delhi High Court has directed a reassessment of tax deductions and disallowances claimed by Vodafone Mobile Services Ltd., stating that critical issues regarding depreciation on Asset Reconstruction Cost (ARC) and interest deductions require further scrutiny. The Division Bench, comprising Justice Yashwant Varma and Justice Harish Vaidyanathan Shankar, examined whether the Income Tax Appellate Tribunal (ITAT) had erred in disallowing depreciation on ARC, rejecting interest deductions on borrowed capital, and classifying discounts to distributors as commission.

The Court observed: "The scope of the remand would necessarily entail the AO not only examining the aspects pertaining to a common pool of funds as framed by the Tribunal but also whether the cell sites had been actually brought into use.” With this direction, the matter has been sent back to the Assessing Officer (AO) for further verification.

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Vodafone Mobile Services Ltd. had challenged an ITAT order dated March 14, 2018, that upheld certain tax disallowances for the Assessment Year 2009-10. The primary issues in the appeal included:

1. Depreciation on Asset Reconstruction Cost (ARC): Vodafone claimed depreciation of ₹5.10 crore on ARC, arguing that it was a present obligation under Accounting Standard 29 (AS-29) and should be eligible under Section 32 or alternatively deductible under Section 37(1).

2. Interest Deduction on Borrowings for Cell Site Towers: The company contended that interest expenses incurred on loans taken for installing cell site towers were revenue expenses and should be deducted under Section 36(1)(iii).

3. Classification of Distributor Discounts as Commission: The ITAT had held that discounts given to prepaid SIM distributors constituted commission under Section 40(a)(ia), necessitating tax deduction at source (TDS).

4. Additionally, the Revenue had challenged the ITAT’s deletion of a ₹14.23 crore disallowance on commission payments and the treatment of penalties paid to the Department of Telecommunications (DoT) under Section 37.

The High Court admitted the appeal and examined whether the ITAT’s conclusions were legally sustainable.

The Court examined each of the contested tax issues in detail.

Depreciation on Asset Reconstruction Cost (ARC)

Vodafone argued that ARC expenses were necessary to restore leased sites to their original condition at the end of the lease period, making them a present obligation rather than a contingent liability. The company cited AS-29, which allows provisioning for future obligations arising from past events.

The ITAT had disallowed the claim, stating that ARC was notional and contingent, making it ineligible for depreciation under Section 32. However, the High Court found that the Tribunal failed to examine Vodafone’s alternative claim under Section 37(1), which allows deductions for business-related expenses.

The Court referred to the Madras High Court’s decision in Vedanta Ltd., stating: "The ARC obligation clearly met the test of a positive obligation flowing from a past event, being a conceivable probability as well as being measurable.”

Since the ITAT had not considered this alternative plea, the Court directed further examination of the issue.

Interest Deduction on Borrowed Capital for Cell Site Towers

The Tribunal had disallowed Vodafone’s claim, reasoning that installing new cell site towers was an extension of business, requiring the capitalization of interest expenses under Section 36(1)(iii).

The Court examined Vodafone’s Directors’ Report, which recorded: "The Company has further expanded its network to increase its coverage across all its circles. During the year, the Company added 5096 cell sites.”

The Tribunal’s observations were contradictory, as it initially held that cell sites were still under construction (Capital Work-in-Progress) but later relied on Vodafone’s report, which indicated they were operational.

Additionally, the Court noted that the Assessing Officer (AO) had not verified whether Vodafone used borrowed capital for CWIP investment or its own funds. The Court directed:

"The exercise which the AO would thus be obliged to undertake would have to cover the twin issues that we have identified above bearing in mind the construction that we have placed on Section 36(1)(iii) of the Act.”

The matter was directed for further verification regarding fund sources and asset usage.

Classification of Distributor Discounts as Commission

Vodafone had contested the ITAT’s classification of discounts given to prepaid SIM distributors as commission, arguing that these were trade discounts and should not attract TDS under Section 194H.

The Revenue relied on the Supreme Court’s ruling in Bharti Cellular Ltd. v. Assistant Commissioner of Income Tax, which held that such discounts constituted indirect commission.

The High Court stated: "Question C concededly stands concluded by the decision of the Supreme Court in Bharti Cellular and thus needs no further elaboration.”

The Court upheld the ITAT’s disallowance under Section 40(a)(ia).

Issues in the Revenue’s Cross-Appeal

The Revenue had also challenged:

1. The deletion of ₹14.23 crore in commission disallowances.

2. The allowance of penalties paid to the DoT under Section 37.

The Court recorded that these issues were not pursued further and required no adjudication.

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The Court issued the following directives:

1. The ARC disallowance was remanded, as the Tribunal failed to consider deductions under Section 37(1).

2. The interest deduction on borrowings was remanded for verification of fund sources and asset usage.

3. The commission payments disallowance was upheld, following the Supreme Court’s decision in Bharti Cellular Ltd.

4. The Revenue’s appeal on penalties and commission deletion was not adjudicated.

The Court disposed of the appeal accordingly.

Advocates Representing the Parties

For the Appellant: Sachit Jolly, Senior Advocate, Soumya Singh, Disha Jham, Abhyudaya Shankar Bajpai, Advocates

For the Respondent: Indruj Singh Rai, Senior Standing Counsel, Sanjeev Menon, Rahul Singh, Anmol Jagg, Gaurav Kumar, Varsha Sharma, Advocates

Case Title: Vodafone Mobile Services Ltd. v. Deputy Commissioner of Income Tax
Neutral Citation: 2025:DHC:1577-DB
Case Number: ITA 660/2018
Bench: Justice Yashwant Varma, Justice Harish Vaidyanathan Shankar

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