Tax dept has strong case against Nokia

The Indian tax authorities are better placed to pigeonhole Nokia Finland over royalty earnings than it was in taxing capital gains in the case of the Vodafone-Hutchinson Essar deal.

The law is equipped to tax earnings accruing to foreign companies from their business connections in India, as in the case of Nokia Finland. But it is caught flat-footed in trying to tap Indian companies making capital gains through many-layered overseas transactions, as in Vodafone. The existence of shell companies in tax havens to receive such proceeds puts them beyond the reach of law.

In the Vodafone case, the holding company of the Indian arm of Hutch was located in an offshore tax haven, and therefore passed off as a foreign company. The sale of shares of the Indian arm was not regarded by the Supreme Court as a transaction to be pursued by Indian tax authorities.

The case involved the acquisition by Netherlands-based Vodafone International Holdings BV (and controlled by Vodafone UK) of shares and controlling interest of CGP Investments Holdings Limited from Hutchinson Telecommunications International Ltd.

The company purchased by Vodafone had a stake in Hutchinson Essar Limited that managed the mobile telephony business in India. Therefore, through a series of layered transactions, Vodafone acquired the telecom business of Hutch in India.

The department’s contention was that since the transaction pertained to the sale of a business located in India, it should be taxed under Indian rules. The Vodafone counsel argued in court that it was not a sale of a business but just a “share” between two foreign entities, and that since it is a capital asset, it can be taxed in India only if it is located in India.

Manipulative companies

Tax havens and banking secrecy laws have been frustrating the legitimate claims of governments of beneficiaries.

The then Finance Minister Pranab Mukherjee’s efforts to to plug the loophole was assailed both by Vodafone and the commentariat, by and large.

India is not alone in finding itself at the receiving end of MNC’s formidable manipulative skills. The US Inland Revenue department has a brief against its own resident company, Apple. Apple has been accused of evading tax to the tune of a whopping $74 billion by setting up a web of shell companies abroad. Its ire is especially against Ireland. The same goes for Britain vis-à-vis another American giant, Google, though it is reported that the latter is now suing for peace.

DIFFERENT WITH NOKIA

With Nokia, however, the Indian tax authorities are on a stronger wicket. Section 115A of the Income-tax Act, 1961 obliges an Indian resident to deduct a 10 per cent tax from royalty payments to a foreign company. Nokia India has been paying Nokia Finland royalty for software downloaded into the handsets made in India. Nokia India is admittedly a resident of India.

Unlike in case of import of goods, including machinery, where the Indian tax authorities have to establish a business connection in India in order to be able to tax a foreign company, there is no such onus as far as import of technology, borne out by payment of royalty or fees for technical services, are concerned.

The very fact that the royalty is related to use of technology for manufacturing goods or services in India for earning income in India is sufficient to make the foreign company cough up tax in India --- no matter where it is located or where the technology was passed on to the Indian resident. It is immaterial how the technology, the handset software, was imported.

The Indo-Finnish double taxation avoidance agreement does not help Nokia either. It also concedes that a 10 per cent withholding tax can be deducted. The only point of contention is whether Nokia Finland passed on the technology in India.

But then this is immaterial, given the overarching provision in the Indian law that presumes a foreigner’s connection with India as far as royalty earnings are concerned.

Nokia cannot invoke the mutual agreement procedure to sort out the dispute, because that procedure is available only for business income of a Finnish resident in India, whereas the present dispute is about royalty.

The relief Nokia has obtained from the Delhi High Court, asking the Indian tax authorities to defreeze its bank accounts, is not a cause for celebration.

One may wonder in this connection whether the Indian law is reasonable, given the rate of technological advances the world over. What is wrong if Nokia develops software in China and that is downloaded in India?

There is absolutely nothing wrong, if Nokia does not mind this; but if, for such downloading, royalty is to be paid, the Indian government will demand its share. How can the Indian government put its shovels into what apparently is foreign income?

To this the Indian tax laws’ answer is the connection with India ---- Indian companies are downloading the software and thereby making their products marketable and enhancing their profits, aren’t they? And this stance of the Indian tax law derives sustenance from the UN model which swears by the source rule of taxation. India says the source of the MNC’s income is in India.

Multinationals prefer the OECD model of taxing multinationals that swears by the residence rule. According to the OECD model,

Nokia Finland is not a resident of India and its tax liability is to the Finnish government, and not the Indian government. But as the Indian law stands today, tax authorities are on a strong wicket.