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Amit M. Sachdeva is a Senior Associate in the international tax practice of Vaish Associates, New Delhi
The Finland-based Nokia group, which has been in India since the mid-1990s through a wholly owned subsidiary, Nokia India Private Limited (Nokia), has had phenomenal success in the sub-continent. However, in more recent times, which coincide with the bad times that Nokia is generally going through, it has been entangled in a multi-million tax dispute with the Indian tax authorities. The Government of India and Nokia continue to wrestle the dispute as Nokia prepares to be taken over by the software giant, Microsoft. This paper recaptures the events so far and reflects some thoughts on India's (changing) approach to international taxation.
The basic controversy in Nokia's INR20.80 billion (approximately US$320 million) dispute revolves around the categorisation for tax purposes of the payments made by Nokia to its parent company for software supplied by the latter to the former for use in handset devices which are manufactured by Nokia in India.1 The position of the Indian Government is that these constitute “royalties” both under Indian Income Tax Act, 1961 (ITA) section 9(1)(vi) and Article 12 of the India-Finland Tax Treaty (the tax treaty) and are therefore taxable in India.
The ITA section 9(1)(vi) definition of “royalty” has been widened over years. What Nokia appears to be relying upon is ITA section 90(2)2 read with the tax treaty definition of “royalties”. Article 12(1) of the tax treaty permits the source country (in this case, India) to levy income tax at a rate not exceeding 10 percent of the gross amount of royalties payable to a resident of Finland. The term “royalties” is defined in Article 12(3)(a) to mean “payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, and films or tapes for television or radio broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.”
At the heart of the controversy is the interpretation of the language of Article 12(3)(a) of the tax treaty and whether Nokia was consequently liable to withhold tax under ITA section 195 while making payments to its parent company in Finland. The offshoot of a failure to withhold tax where there is a legal obligation to do so, is an assessment and tax and interest recovery from the payer under ITA section 201(1)/(1A). A separate consequence of defaulting the withholding tax obligation is the disallowance of deduction in respect of the payments made.3 On the aforementioned understanding of tax treaty Article 12 and of Nokia's perceived legal obligation to withhold tax, the Indian tax authorities down raided Nokia's Chennai factory sometime in January 2013 and subsequently served Nokia with a whooping tax demand alleging failure to discharge its withholding tax obligations and return its full and accurate income since 2006. The demand was intuitively raised in March: the last month in the fiscal year in India, based on which the budget allocations are finalised. Surprisingly, in the notice of demand issued to Nokia, the moratorium period allowed to Nokia for payment of demand was shortened from the statutory period of 30 days to 5 days. The time period for payment was however extended to the full statutory period by the Delhi High Court in an order passed in a writ petition filed by Nokia.4
In an attempt to shortcircuit the merits of the controversy, Nokia approached the Delhi High Court, invoking the court's extraordinary writ jurisdiction under Article 226 of the Constitution, only to be directed to pursue a regular and ordinary remedy against the orders of the tax officer by way of statutory appeals to the Appellate Commissioner.
The Commissioner, after nearly five months from the raid of Nokia's factory, confirmed the action of the revenue authorities. This was followed by a strict follow-up for recovery of the tax demand.
The matter was carried in appeal to the Income Tax Appellate Tribunal in an appeal against the Commissioner's affirmation of the order of the revenue officer. Before the Tribunal, Nokia also sought an order restaining the Government from enforcing recovery of demand during the pendency of the appeal before the Appellate Tribunal. “Pursuant to an interim order passed by the Tribunal, a meeting was held and in terms thereof order dated June 21, 2013 was passed under which Nokia agreed to make payment of INR7 billion (approximately US$107 million) in instalments. [T]hree instalments of INR500 million each were paid”5 by Nokia according to the schedule agreed upon with the Government. This demand became the matter of much hype in the summer of 2013.
On September 03, 2013, Nokia agreed to Microsoft's acquisition of its mobile division. Perturbed by this deal, the revenue authorities, in an attempt to protect themselves against any contingencies arising out of the deal, invoked the provisions of ITA section 281B and passed a freezing order restraining Nokia from selling, disposing or otherwise creating any third party rights in its assets and from operating its bank accounts, until the attachment orders remained in operation. This order was passed on September 25, 2013. Under ITA section 281B, the tax authorities have plenary power to pass provisional garnishee orders injuncting the transfer/alienation of assets and operation of bank account(s) by a taxpayer where the authorities are of the view that doing so is necessary to secure the interest of the revenue in respect of future demands that may be created in view of pending audit proceedings.6
The motivation for passing the controversial September 25 order appears clearly to be the Nokia-Microsoft deal. The High Court order partly lifting this provisional attachment, gives a count of the submissions made on behalf of Nokia, is instructive:
“… It is submitted that during [the] course of the meeting with the Commissioner, … World Head of Taxation, Nokia Corporation and … authorised representative, Nokia India Private Limited had appeared and were asked about the agreement between Nokia Corporation and Microsoft Corporation. However, they were not able to give details as the said officers claimed that they were not conversant with the nuances and the deal was still to be approved by the shareholders of Nokia Corporation. Further, they could not furnish any declaration whether Microsoft Corporation would bear and pay unpaid and outstanding liability of Nokia India Limited.”
It merits a mention that the September 25 order provisionally attaching fifteen bank accounts of Nokia was passed in anticipation of audit orders for future years and was far from the proceedings for the years whose tax demand was agreed to be recovered under the payment schedule referred above.
On hearing of the frozen bank accounts and assets, the company successfully petitioned the Delhi High Court which, vide order passed on September 26, 20137, lifted the bank attachment order, though some of the assets continued to be under injunction. The High Court also imposed several other restrictions on the ability of Nokia to deal with its funds and assets. The following is the extract from the operative part of the order:
1. “ The petitioner will not surrender the lease hold rights or transfer the ownership rights in respect of any of the immovable asset[s] or transfer the fixed asset[s] to any third person.
2. The petitioner will be entitled to receive debts created receivables, loans and advances but the amount so received will be deposited in the bank accounts mention in sub-para D of para 2.6 of the impugned order.
3. The petitioner will not transfer, sell or alienate movable plant or machinery located in the immovable properties mentioned in Clause B of para 2.6 of the impugned order.
4. The petitioner will be entitled to operate the bank accounts in normal course of business and will file monthly statement of bank accounts with the assessing officer in hard copy as well as by sending details via e.mail at the address which may be provided by the assessing officer to the petitioner.
5. The petitioner before repatriating any money abroad will inform the assessing officer at least two working days in advance. The assessing officer, in case, finds the transfer of money concerning or questionable, he will be at liberty to approach this Court for appropriate orders.
6. No dividend will be transferred abroad without permission of the Court till the next date of hearing.”
While Nokia has signalled itself to be at peace,8 there are real doubts about this external calmness, in view of the Nokia-Microsoft deal that, despite the conclusion, awaits its closing scheduled in the first quarter of 2014: a time not too far away for Nokia/Microsoft to remain complacent. At the time of writing of this paper, the tax dispute is known to have come up in the October 15 meeting between the Indian and the Finnish commerce ministers, who appear to have left the issue to the courts and the finance ministries.9
Nokia is one of the latest additions on Indian tax authorities' recent scan radar of multinational corporations operating in India through different models and holding structures.
Late though, the Indian Treasury seems to have realised that these multinationals have deep pockets and (consequentially) have great potential to pay taxes. There is also a growing perception among the tax administrators that transnational corporations reap economic fruits from investment in India Inc, without proportionately contributing to India's fair and equitable share of taxes. This tendency is seen as a direct consequence of India's inheritance of the UK's common law doctrine in Duke of Westminster -- rather than the US’ Gregory v. Helveringeconomic substance principle -- which seems to have “blessed” (aggressive) tax planning.
The executive have begun to take a much stronger view of international tax planning that they view as a catch-22 situation--resulting in economic distortion between those with the resources to engage tax planners and thereby reduce their tax burdens and those without the resources and their consequential inability to reduce their tax. Their view was (and continues to be sometimes) vindicated by the legislature that enacted a flurry of the ill-famous retrospective amendments early 2012. India has also recently notified the much-debated provisions on General Anti-Avoidance Rule (GAAR).
On the other hand, Azadi Bachao Aandolan10 and the more recent and much publicised Vodafone International Holdings11 decisions seem to be clear indicators of Indian courts' adoption of and continued commitment to the Duke of Westminster-type “arrange your affairs to attract minimum taxes” view of tax law and planning.
Regardless of the policy which the Government may choose to pursue, and regardless of its perception of the correlation between foreign investment, growth of the economy and the attractiveness glossing from tolerance of tax planning, the manner and means adopted by the tax administration in the Nokia dispute appear to be too skewed and aggressive to pass the test of Constitution Article 265 which prohibits the “levy or collection” of tax except according to law. The real challenge is to appreciate the difference between a formalistic compliance of law and the faithful adherence to its spirit.
Amit M. Sachdeva is a Senior Associate at Vaish Associates. He may be contacted by email at email@example.com. The author wishes to thank Ms. Arpita Goswami for her support in the writing of this paper.
1 It may be highlighted that this dispute is separate and distinct from Nokia's tiff over a smaller (a tenth in size) dispute with regard to which the Indian tax authorities alleged Nokia to have erroneously claimed software export exemption. See, http://online.wsj.com/news/articles/SB10001424127887324412604578512521596124236
2 ITA section 90(2) offers the taxpayers a choice to apply the provisions of the ITA or an applicable tax treaty whichever of the two is more beneficial to the taxpayer.
3 ITA Section 40(a)(ia).
5 As stated in the order lifting attachment passed by the High Court on September 26, 2013 (infra).
6 This is a power different from the power under ITA section 226 that enables the authorities to direct a taxpayer's debtors to pay direct the amount owed by them to the tax authorities. Any such payment by a debtor constitutes, in law, a valid discharge of the obligation of the debtor to the taxpayer.
7 A copy of the order is available from the webportal of the Delhi High Court and can be accessed here: http://delhihighcourt.nic.in/dhcqrydisp_o.asp?pn=199204&yr=2013
8 For Nokia's statement that the attachment did not affect Nokia's regular production or other business operations not its deal with Microsoft, see, http://www.ft.com/cms/s/0/70304f76-2a71-11e3-8fb8-00144feab7de.html#axzz2hqVsAgkN
10 263 ITR 706 (SC).
11 341 ITR 1 (SC).
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