Taxing time for corporates in India

December 22, 2013 7:43 am

Taxing time for corporates in India

By James Crabtree in Mumbai

Two weeks ago in Helsinki, Nokia executives waited nervously for word from a courtroom halfway around the world in New Delhi. At stake was their ability to transfer a large Indian factory to Microsoft, as part of the sale of Nokia’s €5.4bn phone business to the US group – a move that led to a fierce tax battle, involving dawn raids, frozen assets, and claims adding up to $1.1bn.The court’s ruling proved a reprieve. Nokia’s Indian assets were unfrozen and theMicrosoft transfer could proceed. But the broader tax dispute remains unresolved, and looks set to drag on for years to come.

The Finnish phonemaker is just the latest of a series of global businesses to tangle with India’s revenue service, which – through its habit of harrying foreign companies and obstructing international transactions – has gained a reputation as the world’s toughest tax authority.

Its increasingly diligent efforts mean that roughly Rs2tn ($32bn) is still locked up in tax disputes in Asia’s third-largest economy, according to BMR Advisors, an Indian professional services firm.

“In 2013, tax became a core risk for investors in India,” says Ron Summers, the head of the US-India Business Council, a trade body based in Washington. Disputes piled up, he explains, “clouding India’s investment climate” and leading to the “perception of gridlock” as a string of major companies found themselves in seemingly endless disputes.

Some of these have focused on the taxation of royalties – the fees paid between an Indian subsidiary and its global parent, as in Nokia’s case.

Others have involved share transfers or acquisitions, including a $2.7bn case facing Anglo-Dutch oil groupShell, and perhaps the most high-profile scrap of all: the epic six-year, $2.6bn battle over alleged capital gains involving UK-based telco Vodafone, which remains in limbo.

Vodafone, and others, have also found themselves mired in a different set of squabbles over “transfer pricing” – the way global companies account for services provided by local subsidiaries. In many cases, these involve back-office functions run out of India. Transfer pricing disputes have risen most dramatically of all, rocketing from just Rs12bn ($197m) to Rs700bn ($11bn) over the past decade.

But while there is a natural antagonism between revenue authorities and taxpaying companies, there is little evidence that western groups in India have used subsidiary structures to escape tax – a charge laid against Starbucks and Amazon in the UK.

“Do multinational companies try to avoid tax in India?” asks Mark Runacres, the head of the British Business Group in New Delhi. “None I know would want to break the law. But they, of course, bring considerable expertise in tax reduction from their global experience.”

Nonetheless, the aggressive response of India’s tax authorities to such expertise has left many foreign businesses stunned. Some of them have described, in pained terms, an environment of arbitrary and often-capricious investigations that goes well beyond the stance of other emerging markets.

India’s tax officers are as smart as any anywhere in the world, and western companies who bank on their being unsophisticated tend to make a big mistake

– Dinesh Kanabar, deputy CEO KPMG India

“It’s a crazy system, where any tax officer can slap a demand almost anywhere in the country,” complains a senior executive at a global group caught up in a prominent dispute.

Outrageous tax demands can arrive without notice, the person claims. Long-agreed rules suddenly change. Court cases drag on for years, if you are lucky – or decades, if you are not. “We have learnt that we need lawyers sitting ready to go in all manner of Indian cities, just waiting in case they try to launch some surprise proceedings,” the executive says.

India’s slowing economy has been a factor in the recent moves, as politicians in New Delhi, concerned over rising fiscal deficits, have issued stern edicts demanding ever-greater tax-raising efforts. But legal experts say more complex underlying issues are at play as well, often relating to India’s relatively recent embracing of globalisation.

Risks over transfer pricing are also especially acute in India given the IT hubs in Bangalore and Hyderabad that specialise in “virtual” services. These are tricky to tax but easy to shift around the globe.

Even so, companies would be unwise to think they can exploit a lack of competence at India’s revenue service, warns Dinesh Kanabar, deputy chief executive of KPMG in India. “India’s tax officers are as smart as any anywhere in the world, and western companies who bank on their being unsophisticated tend to make a big mistake,” he says.

Where there is a failing, suggests Mr Kanabar, is in India’s decentralised revenue model.

“Tax policy in India is geared so that a tax officer in the field is supreme, he is like a god,” Mr Kanabar says. “There are thousands of them, and each interprets the law in the way he sees fit. And its this which leads to the perception of anarchy and chaos.”

Rising fears over India’s tax policy have not stopped investment in India, however.

Colin Day, the chief executive of FTSE 250 plastics group Essentra, which opened its first factory in Bangalore last week, says dealing with the tax office can be “a bit of a nightmare”, but remains manageable.

Amid all the disputes, no global company has left the country citing its tax regime. Some, such as Vodafone, continue to invest substantial sums, despite their altercations. Most simply arm themselves with lawyers and soldier on – viewing tax disputes as a cost of doing business in India’s fast-growing market.

KPMG’s Mr Kanabar even sees room for optimism that 2013’s level of tax disputes might fall in the next few years, if advanced warning of tax demands, or new forms of dispute resolution, are introduced. Others feel a change of government after national elections in 2014 could help, especially if opposition leader Narendra Modi makes good on his pro-business rhetoric.

This could, in turn, overcome the more basic problem of the disparity between what India’s government says it wants to do – to attract foreign direct investment, for instance – and the signals it sends to its vast army of tax collectors.

“The Indian government, corporately, does not see itself as the demander in its dealing with multinational groups – rather the contrary,” says BBG’s Mr Runacres. “So this is part of the painful process of India engaging with the global economy – and wanting to do so on its own terms.”

India, tax and globalisation

Might antiquated laws be to blame for India’s tax troubles? Apparently not. “It isn’t a problem with the Indian tax code, but rather the mentality of its tax inspectors,” argues Nikhil Mehta, a barrister who works both in India and the UK.

During India’s long history as a closed economy, its tax authorities learnt to be suspicious of foreign entanglements, and specialised in stopping illegal cash – often known as “black money” – being ferreted away abroad.

“The Indian authorities were used to cracking down hard on tax avoidance and black money,” Mr Mehta says. “When the global companies arrived, that is the template they had. So they cracked down.”

Other difficulties stem from problems faced my developing economies more broadly. “India’s tax department is paranoid about the risk of ‘base erosion’,” claims one senior figure who worked in Mumbai’s tax office – speaking on condition of anonymity – referring to fears that the tax base is under threat from revenues disappearing to western countries.

This fear is reasonable, he argues. A recent OECD paper on base erosion warned that “in an increasingly interconnected world, national tax laws have not kept pace with global corporations, fluid capital, and the digital economy”, posing a particular risk for emerging economies.