Explained - Nokia Tax Row, Chennai Plant Controversy

7/29/2014 Explained: Nokia Tax Row, Chennai plant controversy
http://mrunal.org/2014/05/economy-nokia-tax-row-royalty-payment-chennai-plant-finland-dtaa-microsoft-takeover-unicitral-tds-withholding-tax-explained.html 1/10
[Economy] Nokia Tax Row: Royalty Payment, Chennai Plant, Finland DTAA, Microsoft Takeover,
UNICITRAL, TDS, Withholding Tax explained
CSAT

1. Prologue
2. Royalties: Drain of wealth
1. #1: Quantitative restriction on
royalties
2. #2: Tax on Royalties paid
3. Royalties: TDS (Tax deduction at
source)
4. What Happened in Nokia Royalty case?
1. Timeline: Nokia Royalty Case
2. Nokias excuses
3. Nokias current legal-strategy
5. UNCITRAL / Nokia BIPA
6. JayaLalithas problem?
7. Mock Questions
Prologue
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UPSC (Mains) General Studies Paper 2:
1. Write a note on the structure and functions of UNCITRAL.
Interview questions:
1. What do you know about the tax controversy of Nokias Chennai plant?
2. How is Nokias tax dispute different or similar to Vodafone-Hutch controversy?
3. Will this affect takeover by Microsoft?
Royalties: Drain of wealth
Whenever MNCs setup subsidiary companies in 3
rd
world countries, they keep design patents
in first world Headquarter in USA, UK etc.
Example, in case of Nokia, all design patents, software patents are held by main boss
company in Finland.
So, whenever Nokias subsidiary companies in India, Pakistan or Somalia manufacture any
handset=> royalty is paid to its parent company in Finland.
After subtracting such royalty payment, staff salary, lightbill, office rent, raw material cost etc.=>

days
26

hrs
23

mi ns
07

sec.
46
What's New? ?
profit left.
Higher the royalty=less profit for subsidiary (Indian) company= less corporate tax for Indian
government and dividend to Indian shareholders (if any.)
To prevent this Drain of wealth through royalties, Indian Government uses two methods:
1. Quantitative restriction on royalties
2. tax on foreign parent that earns royalties
Lets check them one by one:
#1: Quantitative restriction on royalties
ProductSales
occurring on
maximum royalty that can be paid to foreign
parent
if foreign company gave us
technology transfer
if no
technology
transfer
Indian soil 5% 1%
Exported
abroad
8% 2%
In other words, if foreign company transfers technology to its Indian subsidiary- we allow them
to take back more royalties as a gesture of goodwill.
Maximum 8% means if one Nokia phone sells for Rs.1000, then Nokia(India) can sent upto 80
rupees to its Finland parent, as royalty payment.
#2: Tax on Royalties paid
When Indian subsidiary sends royalty ca$h to foreign parent, The foreign parent company has to
pay (direct) tax on it. (because this is one type of income earned from India.)
TDS on Royalties varies as per DTAA
Royalty tax on
foreign company
if India has Double taxation avoidance
agreement (DTAA) with that country
10% (In case
of Finland)
15-20% (in
case of USA)
If India doesnt have DTAA with that country 25%
Royalties: TDS (Tax deduction at source)
Tax on Royalty Payment (in theory)
Lets assume Nokia India sold handsets worth xyz crore and has to pay Rs.25,000 crore to Finland
parent as royalty for the software patents in those mobile phones.
Tax on Royalty Payment (in Real Life / TDS)
IN THEORY IN REAL LIFE (TDS)
Finland Company
receives Rs.25,000
crore.
Finland Company sends
10% royalty tax to
Income tax department
of India. (=Rs.2500
crore)
Nokias Indian company
withholds the Rs.2500 crore
royalty tax. Sends it directly to
our Income Tax department.
The remaining 25000 minus
2500 = Rs.22,500 crore
rupees are sent to Finland
parent as royalty payments.
This TDS- tax deduction at
source. Americans call it tax
withholding.
Newspapers use these terms
interchangeably- sometimes
TDS, sometimes withholding
tax.
What Happened in Nokia Royalty case?
Nokia Finland owns the patent for mobile software used in Nokia GSM handsets.
Between 2006 to 2013, Nokia India sent 5 billion Dollars (=~25,000 crore rupees) to its Finland
parent as royalty payment for that software.
Obviously Income tax department deserves 10% TDS on this =Rs.2500 crores. (as per DTAA
with Finland.)
Numbers not important. Hindu says 2080, Hindu sometimes even says 21000 crore (i.e.
approx. total amount sent). DeccanChronicle says Rs.25,000 crore dispute and 10% = 2500 as
TDS liability. I pick 2500 because its easy to remember.
Anyways who needs to pay this amount? Nokia India. (recall the TDS concept we just learned,
sender has to withhold money.)
But Nokia India didnt cut TDS. Nokia India didnt pay our Income Tax department Rs.2500
crores as tax on royalty payment. hence this controversy.
Since Nokia did not pay taxes on time, IT department puts 100% penalty + interest rate= now
more than 6500 crore needs to be paid.(as of Dec 2013)
Timeline: Nokia Royalty Case
1995
Nokia begins operations in India. Sets up offices in
Mumbai, Chennai etc.
Nokia starts Factory in Tamilnadus SriPerumbudur SEZ
2006 near Chennai. (hence newspapers call it Chennai
factory or Chennai plant.)
2010
India and Finland signs Double Taxation avoidance
agreement (DTAA)
2013,
Jan.
Income tax officials raid Nokias factory in
SriPerumbudur SEZ.
They demand Rs.2080 crore as tax on royalty
payments.
Nokia did not comply.
IT department freezes the bank accounts of Nokia
2013,
Sept.
Microsoft agrees to buy Nokia for 7.2 billion USD.
2013,
Dec.
Delhi HC freezes Nokia Indias assets, in other words
they cannot be transferred to Microsoft. But Nokia
India comes with Jugaad, well keep Chennai plant
out of the Microsoft deal :P
IT department digs deeper and finds another TDS
fraud in copyrights payments. Total liability: 6500 in
software royalty + 4500 in copyright payment to
another corp. of Nokia
2014,
May
Nokia sends letter to Mohan for resolving this matter
under Finland India Bilateral Investment Treaty (BIT).
Nokias excuses
1. yes, India-Finland DTAA permits 10% TDS on Royalties
2. BUT Mobile software are not listed in that Royalty definition under DTAA.
3. For us, mobile software is a raw material, so how can you demand tax on money paid to
purchase it from Finland?
4. Since our factory is in SEZ, we dont need to cut TDS on royalty payments to Finland.
5. At max well pay you Rs.3000 crores to resolve this tax dispute.
6. Weve also played role in Indias growth story. We gave employment to more than 30,000
Indians. In Chennai plant alone, 8000 people work, 20% of them women. (Again numbers not
important, sometimes Hindu says 8000, sometimes it says 6500.)
7. Weve invested more than 650 million Euros in India. We are not a scam company.
8. But IF you continue treating MNC giants like Nokia and Vodafone as scam companies, then itll
reduce incoming FDI to India.
Nokias current legal-strategy
If Nokias Chennai plant is auctioned = itll barely fetch Rs.2000-3000 crores.
But If Nokia honestly pays TDS (penalty+ interest) to IT Dept= more than 6500 crores.
Therefore, Nokia is prepared for the worst possible scenario: let the case continue in
court taarikh pe taarikh. If we are defeated, well only lose the Chennai factory. Still our 6500
MINUS 3000 = 3500 crores will be saved.
Therefore, Nokia has kept Chennai plant outside the Microsoft Deal.
Meaning, Microsoft will takeover Nokias all factories, offices, staff BUT not Chennai plant.
Nokia has even offered voluntary retirement scheme (VRS) to Chennai factory workers. Theyll
also get entrepreneurship training under Nokias Bridge program.
Chennai plant will continue production as Subcontracter / outsourced factory. Theyll supply
handsets to Microsoft owned Nokia brand.
So, even if Nokia is defeated in Indian court, Microsoft will have no legal liabilities, no obligation
to give the tax money.
And finally, some miracle (or suitcase-baazi) could happen and newly elected government may
give relief to Nokia, and whole matter will be put in cold storage.
UNCITRAL
May 2014: Nokia sends letter to Mohan for resolving this royalty tax matter under Finland India
Bilateral Investment Treaty (BIT). This BIT treaty provides that if dispute cannot be resolved in three
months after notice THEN
Option
A
Party can approach local court => we already learned
Nokias present strategy here. (aka Taarikh pe Taarikh,
at max auction the factory). AND/OR
Option
B
Party can approach for arbitration under UNCITRAL.
UNCITRAL is also in news because of Vodafones never ending legal disputes. Therefore,
UNCITRAL becomes important for UPSC general studies paper II last point of syllabus Important
International institutions, agencies and fora- their structure, mandate.
Mock Question
Q. Write a note on the structure and functions of UNCITRAL (200 words)
United Nations Commission on International trade law is the core legal body of UN setup in late 60s.
(1966)
Structure:
60 members elected from UNGA (General Assembly)
Term: six years. Half of the members expire every three years.
Election Quotas to ensure geographical representation from entire world.
India is also a member. Its term will expire in 2016.
Unlike IMF, here the Members dont have to bear additional financial burden. UNCITRALs
budget is entirely paid by UN General Assembly.
Even Non-member states, international / regional bodies can participate
Annual sessions @New York and Vienna alternatively.
Decision by consensus rather than voting.
Functions
1. Reduce legal obstacles, facilitate smooth flow of international trade and investment
2. harmonize trade laws of all countries
3. Drafts model trade laws on import-export, international payment, e-commerce, international
arbitration, public procurement etc. Helps member countries to adopt them.
4. Coordination with other international, regional and national bodies for trade laws.
5. Drafts rules for arbitration for dispute resolution. Parties (companies or states) can use these
rules as guiding principles to settle their disputes.
6. Other than that, UNCITRAL itself doesnt appoint arbitrators or private judges to sort any
disputes
~210 words.
Side notes
Quota system in UNCITRAL election
GEOGRAPHICAL REGION QUOTA SEATS
Africa 14
Asia 14
East Europe 8
West Europe 14
Latin America + Caribbean 10
Total membership 60
JayaLalithas problem?
Jayalalitha demands tax saying Nokia didnot furnish Export PROOFs!
So far we learned whats Chindus problem (= Nokia India did not cut TDS on Royalty payment
to Finland) => UNCITRAL.
But even Tamilnadu government has sent a separate notice to Nokia India.
So, whats Jayalalthas problem? Ans. VAT evasion.
We learned that Nokias factory is located in Sri Perumbudur Special economic zones (SEZ).
In SEZ, factories are given tax relief for a first few years.
Accordingly, Nokia was given following tax reliefs / conessions:
(Central) TAX IF HANDSETS ARE EXPORTED
Excise duty 0%
Export Duty 1%
But these tax reliefs apply ONLY if Nokia Indias handsets are exported abroad.
If theyre sold in domestic Indian market, then Tamilnadu government can demand Value Added
tax (VAT).
Jayalathia(TN
government)
Nokia India has not given us proof that all
handsets were exported. We believe many were
sold in domestic Indian market. Therefore we
demand ~2400 crores as VAT
Nokias
document proofs = nearly 16 lakh pages.
excuse Obviously we cant send them all. Better send
your officials to inspect it in our office!
April 2014, Madras High court order
Nokia India will have to deposit 10% =240 crores.
Tamilnadu commercial tax department have to inspect records and pass order.
GK
Rajiv Suri NOKIA CEO from Manipal university.
Satya
Nadella
Microsoft CEO. By the way, his father was an
IAS.
Helsinki capital of Finland
Mock Questions
Q1. Which of the following is an illustration of Tax withholding Norms?
1. After receiving royalties from its Indian subsidiary, Nokia Finland sends tax proceeds to Indian
government.
2. While selling ABC Company to Vodafone London, Hutch Hongkong withholds xyz crores as
Capital gains tax (CGT) and pays to Indian government.
3. While buying ABC Company from Hutch Hongkong, Vodafone London withholds xyz crores as
Capital gains tax (CGT) and pays to Indian government.
4. None of above
Q2. Why are Nokia India and Income tax department involved in a court litigation just before takeover
by Microsoft?
1. Because while selling the company to Microsoft, Nokia did not pay capital gains tax (CGT) to IT
Department of India.
2. Because while buying the company from Nokia, Microsoft did not withhold capital gains tax
(CGT) for IT department of India.
3. Because Nokia Finland sold its shares of Nokia India ltd. to Microsoft via a post office company
in Cayman Islands to evade capital gains tax (CGT) from IT department of India.
4. None of Above.
Q3. Consider following statements about the Tax on Royalties paid to foreign entities.
1. It is an example of Indirect Tax
2. In real life, it is collected from the receiver and not from the sender.
3. It is 100% exempted in case of royalties sent to countries that have DTAA agreement with India.
4. It is 100% exempted in case of royalties sent to NRI authors that pay regular Income tax in
India.
Answer choices
1. only 1 and 3
2. only 2 and 3
3. Only 1, 3 and 4.
4. None
Q4. Correct statements about United Nations Commission on International trade law.
1. All the member states of IMF are ex-officio members of UNCITRAL.
2. Indias membership to UNCITRAL expired in January 2014.
3. Only sovereign states can approach UNCITRAL for arbitration.
4. None of above.
Q5. When Nokia or Vodafone says we want arbitration under UNCITRAL to settle our tax dispute
with Indian government, it means ___.
1. We want our case to be heard at UNCITRALs international trade law court located in Vienna.
2. We want UNCITRAL appointed Foreign Judge to resolve the dispute.
3. We want UNCITRALs executive body to settle this case.
4. None of above
Official answers
1. C: the buyer has to withhold tax & pay to government. TDS=tax withholding norm.
2. D: None of above. Nokia = royalty TDS matter
3. D: None. All statements are wrong
4. D: None of above
5. D: None of above
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