The Indian telecom sector has witnessed an increase in tax litigation in the recent past, which is affecting investor confidence. Although the removal of the foreign direct investment (FDI) cap and introduction of the unified licensing regime are likely to encourage long-term investments in the sector, greater clarity is required with regard to spectrum trading, and merger and acquisition (M&A) guidelines. Industry experts share their views on the recent legal and tax issues…

What is your view on the current telecom regulatory environment in India? How does the Indian telecom sector fare vis-à-vis that in other countries in terms of the investment climate?

Asim Abbas

The sector has witnessed significant developments in the recent past:

•The National Telecom Policy, 2012 has driven equitable and inclusive economic growth through an emphasis on providing quality telecom services in rural and remote areas. The policy lists new initiatives in providing free roaming to consumers, ensuring unrestricted internet telephony and introducing the unified licensing regime.

•The government approved 100 per cent FDI in the sector in 2013, wherein up to 49 per cent investment is allowed through the automatic route. Any additional stake acquisition would require government approval.

•At present, there is more regulatory certainty with respect to spectrum allocation. In terms of the overall investment climate, 2013 has been a better year than 2012. After the Supreme Court’s judgment on the 2G controversy, sector growth reduced as is evident from the sharp decline in FDI in April–November 2012. FDI inflows plummeted by 96 per cent to $70.46 million from $1,987.18 million during April–November 2011. The withdrawal of the FDI limit has ensured that a foreign company does not have to necessarily partner with an Indian company to enter the sector. Further, the introduction of new licences (unified licences) and auction of spectrum in various bands have been beneficial for the sector. We are hopeful that with the fresh auction of spectrum in 2014, the sector will again emerge as a favourite destination for investors.

Rajiv Luthra

The regulatory environment in any sector is primarily shaped by two factors – action at the policy level and regulatory initiatives that are often taken as a consequence of various policy decisions. In the recent past, we have seen a certain sense of urgency in decisions like increasing the FDI cap in telecom to 100 per cent, adopting the auction methodology for spectrum allocation and allowing external commercial borrowings for spectrum allocation over a limited window. This has partly been due to the efforts to stem the decelerating growth in the Indian economy as well as the perception that the Indian telecom sector, at least in its current stage, is not as lucrative as it was earlier. On the regulatory front, there have been certain positive steps like the introduction of the unified licensing regime, prohibition of unsolicited commercial communications and better alignment of tariffs. However, telecom is a capital-intensive sector and regulatory clarity is crucial to ensure investment flow. To this end, the government needs to clarify pending issues related to spectrum trading and M&A guidelines so that investors do not face any policy flip-flop.

The Supreme Court’s decision on the cancellation of telecom licences and spectrum allocation has had a major impact on the investment climate in India. In addition, the huge capital requirement along with restrictions and various conditions on foreign investment in the telecom sector has dampened investor sentiment. However, from a global perspective, investments in emerging economies have been slow over the past few years partly due to the macro-economic downturn as well as local issues like uncertain policies, corruption and infrastructural deficiencies. The Indian telecom market has not been performing very badly as compared to other markets – although given its size, it could have performed better. After the strong growth in the last decade, there has been a trend of consolidation amongst telecom players who are also beginning to understand the dynamics of such a complex market.

Menaka S. Sawhney

The Indian telecom industry has come a long way since the liberalisation era. This is evident from the industry’s phenomenal growth in the past decade. In a major regulatory reform, the government has approved 100 per cent FDI to meet the demand of the fund-starved industry. This move has not only helped the industry to procure fresh funds, which is likely to reduce the financial burden, but also comes as a relief for foreign partners in telecom companies as they can now have complete ownership of the business. As foreign companies are no longer required to form partnerships with local operators, they are showing more interest in the Indian telecom market.

Given that the Indian telecom market is the second largest in the world after China, it fares well vis-à-vis other countries with regard to the investment climate. However, attracting greater capital from other countries will not be easy owing to regulatory uncertainty and corruption, which are the key issues in the Indian market.

What is your view on the various tax cases involving telecom operators? Do you think the legal issues are impacting investor sentiment in the sector?

Daksha Baxi

Some cases such as that of Vodafone have created uncertainty for foreign investors. It has also affected global M&A activities where the foreign company being acquired has any Indian asset. While no tax demand has yet been made by the Income Tax (IT) Department on such international acquisitions since the law was amended in 2012, it has created a significant amount of uncertainty and might have adversely affected the valuations of foreign companies with Indian assets. Two other tax issues that have impacted international M&A activity, including that in the telecom sector, are:

•Infusion of further share capital in an Indian subsidiary of a foreign company (Vodafone’s case is also pending with the court with regard to such an issue): The IT Department has been claiming that such an infusion must be carried out at the price of the Indian company’s shares, which is determined on an arm’s length basis.

•Transfer of telecom tower business: The taxability of such a transfer is impacted based on whether it is a tax neutral hive-off (defined as demerger under the Indian law) or a slump sale. There is a lot of uncertainty in this area. In some cases, the IT Department has not accepted the categorisation of the transaction as demerger, thereby levying tax on the transferor. In other cases, it has refused to accept the transfer as a slump sale categorising it to be an itemised asset sale, which resulted in higher tax incidence.

Despite facing tax litigation in India, Vodafone Plc plans to expand its operations in this market. While the Supreme Court verdict on the 2G spectrum controversy has resulted in some foreign operators exiting this market, others have consolidated their operations. Further, although tax uncertainty is one of the major concerns of these players, positive factors such as the large size of the market have stopped them from pulling out of India altogether.

Rajiv Luthra

The recent rise in the tax litigation against telecom majors like Vodafone is driven by the central Indian government’s efforts to increase short-term tax receipts, curtail the fiscal deficit and meet budgetary targets. Increasing cases of litigation with respect to M&A and deals involving transfer pricing issues have financially burdened Indian telecom companies, which are struggling for profitability due to licence cancellations and payment of one-time spectrum fees.

The uncertainty in the tax regime and its negative impact are major deterrents to new investments. Moreover, some of the potential long-term investors are embroiled in tax litigation, which might discourage future investments in the sector. As per FDI statistics published by the Department of Industrial Policy and Promotion, the sector’s share in the country’s total FDI reduced from 7.75 per cent in 2010-11 to 1.36 per cent in 2012-13. During April-November 2013, the sector received FDI worth only Rs 1.98 billion, which accounted for 0.21 per cent of the total FDI flow into the country.

Menaka S. Sawhney

The retrospective amendment to tax laws and the aggressive position taken by the Indian tax authorities on transfer pricing issues have had an adverse impact on foreign investor sentiment, including investments in the telecom sector. Typically, foreign investors prefer certainty regarding the tax implications associated with business transactions. The government must, therefore, take steps to ensure that investment in the sector is not affected due to uncertainty in taxation laws.

What could be the legal issues for telecom operators opting for M&As in India?

Asim Abbas

The M&A guidelines have not yet been finalised. The Empowered Group of Ministers (EGoM) on Telecom has given its recommendations on this issue, which are subject to approval by the cabinet. The implications of M&A guidelines will be clear once the Department of Telecommunications releases the detailed guidelines. That said, the government needs to provide clarity with regard to the following:

•Definition of market share

•Payment of differential prices in case the merging entities hold spectrum under the administrative or auction regimes

•The overall capping of spectrum.

Rajiv Luthra

Although the EGoM on Telecom recently approved the long-pending M&A guidelines for the sector, they are yet to be notified and examined in detail. The previous guidelines were archaic, restrictive and regressive; left significant scope for ambiguity; and were consequently not well received. Implementation of new M&A guidelines would offer more clarity regarding issues related to spectrum trading before consolidation or any other M&A activity. Especially, large telecom companies with a pan-Indian presence would not be interested in acquiring entire companies, which may result in duplication of infrastructure, unnecessary debt and legacy issues. They will look to acquire specific assets such as unused spectrum. Mid-level companies, on the other hand, may look to merge or acquire smaller companies to augment their infrastructure and increase the subscriber base. Further, the recent guidelines have increased the market dominance criterion to 50 per cent of the market share in terms of subscriber base. However, as spectrum is a scarce resource, (even in a scenario where a company does not meet the market dominance criterion but has a large volume of spectrum) issues under the competition law cannot be ruled out in the case of a merger.

Menaka S. Sawhney

Amongst the various issues related to M&As, one of the major legal concerns for telecom companies is to comply with multiple regulations for completing a transaction. Also, every transaction that triggers the provisions of the Competition Act, 2002, with regard to asset or turnover prescribed thereunder is mandated to obtain prior approval from the Competition Commission of India. Further, telecom operators opting for M&As are required to comply with the Securities and Exchange Board of India regulations.

Given the recent developments pertaining to the M&A guidelines, it may be very early to identify all legal issues. The government’s decision to raise the cap on the market share of a merged entity to 50 per cent is a positive move. On the other hand, the decision that companies will have to pay the market-determined rate of spectrum is being viewed as a negative step. However, clarity on M&A norms is an encouraging development for the sector.

In the past, several telecom companies have approached courts over various legal issues. Does this reduce the importance of the Telecom Disputes Settlement and Appellate Tribunal (TDSAT)?

Asim Abbas

TDSAT was established for a specific purpose and its jurisdiction is defined in the Telecom Regulatory Authority of India (TRAI) Act, 1997. Its importance will not be diluted since it is a specialised administrative tribunal created for the settlement of disputes in the telecom sector.

Rajiv Luthra

A close look at the instances where civil courts have entertained legal issues pertaining to the telecom sector, to the exclusion of TDSAT, would classify the cases into two categories. First, although the jurisdiction of the civil courts is barred under the TRAI Act, 1997, well established jurisprudence in India allows parties to file a writ petition in the high court or the Supreme Court and this right cannot be barred under any act. Second, the parties try to find a way to circumvent the TRAI Act, 1997 by filing petitions on matters that do not fall under the jurisdiction of TDSAT. However, TDSAT still assumes much relevance as the civil courts generally have been wary of considering matters under TDSAT’s jurisdiction. The role of TDSAT is to adjudicate on any dispute between a licensor and licensee; two or more service providers; a service provider and a group of consumers; etc. It also hears and issues rulings/verdicts on any decision or order issued by TRAI. However, if the dispute pertains to interpretation of the law, fundamental rights, etc., it must be resolved before the high courts and the Supreme Court, which are the competent authorities for the same.

However, it needs to be kept in mind that civil courts should be extremely cautious about allowing themselves to be used as an alternative forum. Often litigants looking for a quick remedy approach these courts for interim orders. Such a practice of “forum shopping” should be discouraged as it militates against the specific policy objective for which TDSAT was set up, that is, to allow a technically competent body to adjudicate on matters in the telecom sector to ease the burden on the judiciary.

Menaka S. Sawhney

The involvement of civil courts in resolving legal issues in the telecom sector does not affect TDSAT’s relevance. TDSAT is a statutory body under TRAI and has exclusive jurisdiction over telecom matters. Further, it is also a court of first instance and continues to have powers to hear matters where the vires of statutory provisions are questioned. While it is true that telecom companies have approached multiple courts over various legal issues, they approached these courts on matters challenging the validity of legislations. These issues fall under the jurisdiction of civil courts, which is distinct from that of TDSAT, and, therefore, do not reduce the latter’s importance.

What is your opinion on the Supreme Court verdict stating that TDSAT has no power to evaluate regulations issued by TRAI?

Asim Abbas

In a judgment, the Supreme Court has reiterated the same principle applicable to other sectors in India, which also have  regulatory authorities and adjudicating tribunals. It has not curtailed TDSAT’s juridical powers for settling disputes as envisaged in the TRAI Act. Also, the scope/applicability of the judgment is only limited to Section 36 of the TRAI Act.

Rajiv Luthra

The Supreme Court recently stated that TDSAT has no power to test the legality of guidelines framed by TRAI. This judgment has far-reaching effects. According to the Supreme Court, TDSAT is a quasi-judicial body and its authority is restricted to reviewing directives, decisions or orders issued by TRAI pertaining to the TRAI Act and this does not include regulations (notified by TRAI as subordinate legislation under Section 36 of the act). Since such regulations are also required to be placed in Parliament, TDSAT has no power of judicial review on them. In my opinion, it was not the intention of Parliament to exclude the jurisdiction of TDSAT over such regulations. However, the Supreme Court used legal precedents as well as interpretative tools to arrive at the decision. Further, Section 14 of the TRAI Act (which sets out the powers of the TDSAT in relation to settlement of disputes) has not been worded properly.

This ruling takes away TDSAT’s powers to review the legality of regulations issued by TRAI. TDSAT can only adjudicate on actions taken by TRAI pursuant to such regulations and orders or directives. The authority to decide on the legality of regulations now lies with the high courts. This could result in delays in disposal of cases. Further, TRAI would have a greater say in the telecom sector. It is unclear if the judgment would retrospectively affect TDSAT’s past verdict.

Menaka S. Sawhney