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AGR Revisited - Implications of TRAI recommendations on redefining revenue calculations

Discussion Board , October 15, 2006

Telecom service providers currently pay 6 to 10 per cent of their adjusted gross revenue (AGR) as licence fees annually, depending on the nature of the licence. Service providers have protested against the current definition of AGR on the ground that it includes revenues that are unrelated to the activities specified under the licence. TRAI recently brought out recommendations to redefine the AGR components. Telecom experts comment...



What is the likely impact of a change in the definition of AGR to the exchequer and to the service provider?


Arpita Pal Agrawal: The Telecom Regulatory Authority of India's (TRAI) recommendations on components of AGR released last month are based on the July 2006 order of the Telecom Disputes Settlement Appellate Tribunal (TDSAT). Its objective is to undertake an exercise to find out which components of the AGR, as defined in the conditions of the licence, deserve to be retained and which ones should be excluded. The extent to which these recommendations are finally accepted and notified by the Department of Telecommunication (DoT) remains to be seen. In principle, it is realised that exclusion of components –­ such as income from dividend, capital gains from non-telecom activities and gains from foreign exchange fluctuations –­ from the definition of AGR, when put into effect, will lead to a comparatively lower outflow of licence fees to the exchequer and improved margins for the service provider.

Nilangshu Katriar: TRAI has recommended that revenue from all activities under the telecom licence should form part of the AGR. Interest calculated on refundable deposit from subscribers, vendor credit, revenue from rent of towers and dark fibres, payments on behalf of third parties, sale of handsets or telecom equipment bundled with telecom services, revenue from TV uplinking and internet services and receipt on account of ADC shall all be part of the AGR.

The following though do not form part of the AGR: income from dividend, capital gains (unless receipts have come from telecom services), reversal of provisions, gains from foreign exchange fluctuations, revenue from property rent (provided it is clearly established that the property is not connected to the establishment, maintenance and working of telecom services), and revenues from discernible and standalone sale of handsets or telecom equipment, not bundled with telecom services. Also, it is recommended that certain deductions –­ for example, costs on account of port and interconnection set-up charges, leased lines, sharing of infrastructure, and roaming, signalling and content charges –­ should not be made for computation of the AGR.

The "total revenue" of telecom companies in India for 2005-06 was pegged at approximately Rs 900 billion. Telecom companies estimate that as much as 15 to 20 per cent of the above was contributed by other sources such as dividend income, equipment sales and management, and consulting revenue. With the current licence fee rate of 6 to 10 per cent revenue share, reprieve on account of non-licensed services (approximately Rs 15 billion) promises to have a very positive impact on telecom pricing. The explicit disallowance of deduction in costs on account of port, interconnection set-up charges and leased lines shall not negate the effect of the above as these were anyway not permitted. However, some service providers used to still try to claim these deductions in their AGR statement.

Archana Sasan: TRAI, in its recent recommendations, has included various components as a part of the AGR, which is the basis on which revenue-share licence fees are calculated for each operator. The guiding principle behind changing the definition of AGR has been to exclude non-telecom activity from calculation of the AGR. Broadly speaking, such a change would prove to be effective while evaluating the revenue earned by a service provider from telecom services. This change could ensure that the exchequer receives its share of the revenue generated.

Earlier, there was ambiguity in evaluation of revenue share, which was to be paid to the exchequer. Now, after a comprehensive change in what is termed as the AGR, this share should reflect the proceeds from telecom services only and not other ancillary non-related telecom activities. The major impact of this would be that the exchequer's share might reduce.

Whether the licence fee payable by a telecom service provider would increase or decrease would depend on the components included by the telecom service provider in what comprises the revenue. However, such modification of definition implies that the procedure of demarcation between telecom and other services-based revenue while preparing annual accounts would be tedious.

Mahesh Uppal: The impact of such a change may not be significant. This move could be an incentive for operators to adopt transparent billing practices. It can reduce the opportunities for arbitrage existing in the present anomalous regime where only revenues from services are taken into account while calculating licence fees. This has been an incentive for some to allocate almost all revenue to handsets in spite of being bundled with the service plan.

Will the inclusion of revenue earned from the sale of handsets bundled with a tariff plan in the AGR be a major setback for telecom operators?

Arpita Pal Agrawal: The recommendations do allow for exclusion of revenue from discernible and standalone sale of handsets or telecom equipment –­ not bundled with the telecom service –­ from the AGR calculation. This will enable operators to evolve innovative schemes to offer handsets without overtly clubbing them with telecom services and having to pay a revenue share on the handset price. With the existing AGR definition also, there exist schemes in the market that offer a choice of select mass-market handset models with service lock-in options.

Nilangshu Katriar: Inclusion of revenue earned from the sale of such handsets is not necessarily apt. It is similar to clubbing computer hardware equipment revenue with that of ISP revenues, should they be sold together. Bundling gives flexibility to come out with innovative offers and prices. However, in case the authorities feel that not including the revenue earned from the sale of handsets bundled with a tariff plan enables service providers to camouflage their services revenue with their equipment revenue, then there are various methods to eliminate this uncertainty. One can use various defined means of accounting, such as the relative fair value method or residual value method, which would clearly establish and segregate the equipment and services element.

Archana Sasan: A change was required to include the revenue accruing out of sale of handsets bundled with the tariff plans. The effect of this may have to be looked into separately for GSM and CDMA operators. Since CDMA operators have been generally selling handsets bundled with a tariff plan, such inclusion could impact their revenues to an extent. This would not seem a major concern for GSM operators as they rarely bundle their tariff plans with handsets. Further, unlike the international telecom market where cellular operators are offering a variety of hi-tech services supported by handsets, operators/service providers in India are currently not doing so, and should not get majorly impacted.

Mahesh Uppal: No, inclusion of revenue earned from such sales is not likely to act as a major setback to service providers. Both handset sales as well the services business are inherently profitable and do not depend on cross-subsidies. Creative marketing should handle this quite easily.

How practical or useful are measures such as revenue sharing for licensing? Is it possible to implement the same without any ambiguity?

Arpita Pal Agrawal: Mostly countries that do not have a revenue-sharing regime for licensing have charged an initial fee and/or auctioned their spectrum. They do not have an annual charge payable for the licence. In India, however, we have moved from an upfront payment regime to a mix of fixed-fee and revenue-share regime due to reasons widely known. This issue is being discussed due to the large percentage of revenue share required to be paid in India compared to the percentage in benchmark countries.

 

Nilangshu Katriar: The basic objectives of the New Telecom Policy (NTP), 1999 had been to ensure availability of effective communication services at affordable rates. It also aimed at striking a balance between provision of universal services to all uncovered areas, including rural ones, and provision of high-level services capable of meeting the needs of the economy. To create a modern and efficient telecom infrastructure, DoT prescribed a one-time entry fee along with a licence fee based on a revenue-share arrangement for different service areas as recommended by TRAI from time to time.

Licence fee on a revenue-share basis is a very practical method for development of telecom services, provided the rates are proactively modified to respond to the fastchanging socio-economic environment. It has been used as a very effective tool by various mature economies to develop and promote the telecom industry. It is a tough task to provide an exhaustive definition of revenue in a highly dynamic economic environment like ours. But if the regulator is proactive enough to monitor newer modes of revenue and costs, and modify/clarify the elements to be included/excluded for computation of the licence fee on a timely basis, the licence fee model based on revenue share can be implemented with minimal ambiguity leading to reduced litigation and effective monitoring.

Archana Sasan: As long as the concept of annual licence fee exists, revenue share is the best possible method of collection by the exchequer. It ensures that a service provider's licence fee is directly linked to the revenue earned by it and therefore is proportional to its commercial success/viability. An alternative to this would be feasible only if it were an accurate representation of the earnings of a service provider.

It is possible to implement a revenuesharing model without too much ambiguity. A change in the definition of AGR will help in removing traces of ambiguity in calculating the revenue of a service provider.

Mahesh Uppal: A revenue-sharing approach to the licence fees has the advantage that the government does well when operators' revenues go up, making the former a de facto stakeholder in the business. However, this was arguably more useful when businesses were floundering due to the huge fees that the operators had bid for but could not afford to pay. Now, the same revenue sharing could be seen by operators as a tax that increases with revenues. What TRAI has proposed removes much of the anomaly surrounding the licence fee calculation.

What could be a better method of licensing for providing adequate incentive to both the exchequer as well as the operator?

Arpita Pal Agrawal
: Telecom services are widely acknowledged as enablers of economic growth and effective engines for bridging the socio-economic divide. This is especially relevant in service-based economies such as India. It is time we recognise this fact in spirit and stop treating the sector as a source of muchneeded revenue for the exchequer. The checks and balances needed in this sphere relate to facilitating and overseeing the sector in a manner that the scarce spectrum resource is used efficiently by operators.

Nilangshu Katriar: The revenue share percentage has come down from 15 per cent at the time of the NTP, 1999 to the present levels of 6 to 10 per cent. However, the same is much higher if compared with some of the other emerging countries in the region and other developed countries. Aggressive growth in the Indian telecom industry has definitely outpaced proactive modification of the licence fee rates. The need of the hour is to have a very moderate licence fee rate coupled with a simple definition of revenue share. For example, the government could charge a direct percentage of the operators' audited revenues ("percentage of the topline" approach) without involving any further additions or deductions. The net margins of telecom service providers in India are much lower than those of operators in emerging and developed countries. It is believed that the current high revenue share licence fee cost is a key reason for this.

Archana Sasan: As stated above, the modified AGR definition and the present system of revenue share provides proportionate and adequate incentives to both the exchequer and the operator. Revenue sharing ensures that operators pay an annual licence fee proportionate to their business productivity. However, in the coming months, the definition of AGR could be further modified to include/exclude certain other activities so that any ambiguity is further reduced.

Mahesh Uppal: Mobile markets are not as much of a mystery today as they were a decade ago. New licences could accompany a reasonable entry fee. Mobile licence fees must be predominantly the charges for spectrum based on transparent criteria. For the current licensees, there is a strong case for specifying a target revenue after which payments to the government could come down or preferably, become zero. This will then produce an incentive for operators to expand services since they would be able to retain a larger chunk of their future revenues. This may help rural areas, which are currently underserved. The government will, in any case, benefit from the increased taxes, productivity, employment, etc.




 
 

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