Taxation Challenges in the Telecommunication Industry
The telecommunication industry is one of the fastest-growing sectors globally, driven by technological advancements and the increasing need for people around the world to connect. Does our tax legislation adequately respond to keep up with these changes? Below we look at some of the facts and complexities of taxation in the telecommunications industry, focusing on relevant tax provisions, recent legal decisions, and their implications for stakeholders.
Applicable Tax Provisions for Infrastructure Assets
The growing telecommunications infrastructure involves significant investment in physical assets like cables, poles, routers, and masts. So how does the current tax framework define and apply tax provisions to these assets? Sections 12D and 11(e) of the Income Tax Act can be applied, but their scope is seen as limited and outdated creating uncertainty in deciding whether a section 12D or 11(e) deduction is more appropriate. Lets look at these in more detail.
Section 12D offers capital allowances specifically for lines or cables used for transmitting electricity or electronic communications, identifying them as ‘affected assets’. This allows companies like Telkom to claim deductions over ten years for the cost of infrastructure such as poles, cables, and related earthworks. 12D, however, still refers to physical lines running underground and does not adequately cover modern technologies like satellites, cell phone masts, and other wireless infrastructure. This gap creates ambiguity, particularly when trying to classify newer assets for tax purposes.
Section 11(e) provides for wear and tear allowances on movable assets, which include equipment like cell phone towers, routers, and antennas. The section defines the expected useful life for such assets, with antennas qualifying for a six-year deduction period and masts for ten years.
These allowances are in place, however, determining what qualifies under Section 12D or Section 11(e) can often be unclear, particularly for assets that are integral to both telecommunication and other corporate operations. For instance, data cables used in automated manufacturing processes blur the line between telecommunication assets and production equipment, leading to further confusion about the correct treatment for tax purposes.
Uncertainty on the Timing of Expense Deductions
Two recent court cases involving major telecommunications companies—Telkom and MTN—have provided critical, though sometimes conflicting, guidelines for the tax treatment of telecommunications-related expenses. They also demonstrated the challenges in applying current provisions in a consistent and objective manner.
The Telkom Case
Section 23H deals with the timing of deductions for expenses that provide benefits beyond the current year. It requires that the expenses paid be claimed over the period in which the benefits are derived by the taxpayer.
The Telkom case demonstrated the fact that the application of section 23H can be subjective. The case revolved around Telkom paying a substantial cash incentive bonus to a dealer for connecting new subscribers. Telkom claimed the entire amount of the bonus paid as expenses in the year it occurred. SARS argued that the benefit from this expense was spread across multiple years, and thus, the deduction should also be spread. This is how it played out at the end:
The Special Tax Court agreed with Telkom that the expense related solely to the year it was incurred.
The Appeal Court overturned the decision of the Special Tax Court, holding that the benefit extended throughout the subscriber contracts and that the deduction should be appropriately spread.
This ruling demonstrates that a simple principle of aligning deductions with the period of benefit can be difficult to apply in practice due to the complexities of telecommunications contracts and revenue recognition.
The MTN Case
The MTN Case (from 2012) focused on the deductibility of audit fees and advisory fees paid to KPMG for work done on their Hyperion computer system. MTN initially claimed the full cost of both fees as tax-deductible. However, SARS argued that most of MTN's income came from dividend receipts, which are exempt from tax, and therefore the fees should be proportionally disallowed. Multiple courts assessed the situation differently:
The Special Tax Court allowed a 50% deduction of the audit fees,
The High Court allowed 94%
The Appeal Court to ultimately settled on allowing just 10%.
This case illustrates how challenging it is to achieve tax certainty in a sector where the source of income and the nature of expenses can be so varied.
VAT Treatment in the Telecommunications Industry
The VAT Act and its application to the telecommunications industry present significant challenges. Due to the international and cross-border nature of telecommunications services, VAT compliance can be complex. Issues such as VAT treatment for customer accounts in credit, international roaming charges, and services provided to foreign entities have highlighted the significant administrative burdens faced by telecommunications companies in providing adequate proof supporting the zero-rating of the supply. Some of the specific circumstances are discussed below.
VAT treatment for customer accounts in credit
In situations where customers prepay or overpay for services, determining the correct VAT treatment can be complicated. Section 8(27) of the VAT Act specifies that if an excess amount is received for a taxable supply and is not refunded within four months, it must be treated as consideration for a supply of services. This means that companies may be required to declare VAT on amounts that were overpaid or prepaid by customers, even if the intention is to refund these amounts later. This creates cash flow issues and additional administrative burdens as companies have to track and manage these payments to ensure compliance.
Treatment of International roaming charges – Section 11(2)(y) of the VAT Act
Charges made to international service providers are zero rated as per section 11(2)(y) of the VAT Act, provided that the services are not consumed in South Africa. However, proving that the services meet all the requirements for zero-rating can be complex, particularly given the intricacies of international roaming agreements and data flows through various networks. I.e. when a customer uses their mobile service in another country, multiple telecommunications providers are often involved in routing and handling the call or data session.
VAT on Telecommunication infrastructure installations
When equipment such as routers and fiber cables are installed in customers’ premises, questions arise about whether these items are “supplied” to the customer or whether they remain the property of the service provider. If the equipment remains the property of the telecommunications company, it is treated differently for VAT purposes compared to when it is transferred to the customer. Additionally, the installation fees charged to customers can be subject to VAT, but the determination of whether VAT should be applied immediately or spread out over the contract term can be unclear, depending on the specific contract structure.
Dissecting Bundled Services for VAT purposes
Bundled services, such as voice, data, and hardware (e.g., a mobile phone) are often provided as part of a single package. Allocating the appropriate portion of the total price to each component for VAT purposes can be challenging, especially when different components may have different VAT treatments. For example, the supply of the mobile device may be subject to standard VAT, whereas certain services could potentially be zero-rated if supplied to non-residents.
Employee Fringe Benefits
Lastly, employee fringe benefits related to telecommunications, such as providing free or discounted cell phones or data packages, must be carefully evaluated for tax purposes. Fringe benefits are taxable to the extent that they are provided for private use.
The provision of such benefits may trigger output VAT if the benefit is considered a supply for VAT purposes. Determining the value of these fringe benefits, particularly when they are provided at a marginal cost to the employer (e.g., free data for employees of a telecommunications provider), can be complex and requires a careful understanding of both VAT rules and employee benefit valuation.
The Necessary Next Steps: Reducing Uncertainty
The above uncertainties when applying the current tax provisions for the telecommunication industry highlights the urgent need for the regulations to evolve. As telecommunications technologies advance, more clarity is required to effectively apply existing tax laws. Modern infrastructure, including satellites, internet gateways, and fiber-optic cables, does not fit neatly within the outdated definitions of current tax codes, leading to varied interpretations by tax authorities and courts.
Learn more about the taxation in the telecommunication industry with CIBA’s October 2024 Tax Happy Hour webinar!
What you will learn:
This webinar will provide you with crucial insights into the tax complexities of the telecommunications industry. You will learn about the practical challenges of applying outdated tax provisions like Sections 12D and 11E to modern telecommunication assets, and how these provisions impact infrastructure investment.
The webinar also explores the intricacies of VAT treatment, especially concerning international roaming, interconnect fees, and bundled services. Additionally, recent court cases involving MTN and Telkom are discussed in detail to illustrate how tax laws are interpreted in this evolving industry. By attending, you'll gain a better understanding of how to navigate compliance challenges in a fast-changing sector, helping you provide more informed guidance to clients or employers involved in telecommunications.
