Taxing Time for Nokia in India

The company which has won the global PC market has been completely flummoxed by the uniqueness of the smartphone market in recent years. Not surprisingly, Microsoft has now announced that it will reconfigure the smartphone hardware business. Technology research firm Gartner’s latest quarterly smartphone sales report, released in May 2016, suggests that Microsoft’s Windows Phone OS has less than 1% market share globally.

Microsoft bought Nokia’s devices and services business in 2013, paying $7.1 billion for it, in an attempt to take on Google’s Android, Apple’s iOS and to a certain extent, BlackBerry, at the time. But this business never quite took off. In July 2015, Microsoft laid off 7,800 people from that acquisition, a move that cost the company $7.6 billion.

The global market share of Windows smartphones has fallen below 1% in the first quarter of 2016, according to research firm Gartner. In India, too, the market share of Windows smartphones is estimated to be less than 2%, with Google’s Android operating system (OS) smartphone market share at over 80%—both globally and locally.

Nokia’s Chennai factory was however kept out of the Microsoft deal as Nokia has been fighting a tax case with the Indian government since 2013. In January 2013, the Indian tax officials had asked Nokia to clarify on non-payment of tax deducted at source on software supplies and change in its accounting model. The income tax department had slapped a notice on Nokia’s Indian subsidiary – Nokia India - for violating withholding tax[1] norms since 2006 while making royalty payments to the parent company in Finland.

Taxes in India are levied by the Central Government and the state governments. Some minor taxes are also levied by the local authorities such as the Municipality. Value Added Tax (VAT) is a major source of revenue for Indian States. Other state level taxes include Entertainment tax, Entry Tax and Octroi.

Nokia and a string of multinational companies have come under the scanner of tax authorities of India. The companies have denied any wrongdoing but tax authorities say they need to protect revenues. Value Added Tax (VAT) is a major source of revenue for Indian States. Other state level taxes include Entertainment tax, Entry Tax and Octroi.

The Madras high court had first stayed the order and then asked Nokia to approach the Commissioner of Income Tax (appeals). In addition to legal action being pursued in India, the Ministry of Finance in Finland has launched the mutual agreement procedure (MAP) with its counterpart in India under the bilateral double taxation avoidance agreement (DTAA)between the two countries to arrive at a mutually agreeable solution.

Here is a timeline of Nokia's tax issues in India:

8-Jan-13	India’s Income Tax department inspects the Chennai factory
21-Mar-13	The Income Tax Department issues Rs 2,080 crore (€250m) tax demand (later rectified to Rs 2,649 crore) on Nokia India, alleging that it has failed to withhold tax on the payment made to its parent as ‘royalty for the software’ used in its mobile phones since 2006
17-Apr-13	The Delhi High court asks the Income Tax Department to re-examine its claim against Nokia and not to take any further coercive action. The court sends the matter back to the I-T Commissioner for fresh examination, and asks him to decide the matter before 31 May 2013
8-May-13	At Nokia India’s request, Finland invokes the Mutual Agreement Procedure (‘MAP’) under the DTAA[2], asking the competent authorities in India to seek an agreement on the application of the DTAA
31-May-13	The Commissioner of Income Tax (Appeals) dismisses Nokia India’s appeal
Jul-13	Nokia India agrees to pay a ‘deposit’ of Rs 700 crore towards ‘stay of demand’ raised by the Income Tax Department and prevent the full amount of the claim by the DDIT becoming payable while it awaits a hearing before appellate authorities
3-Sep-13	Nokia announces that it intends to sell its Devices & Services division to Microsoft
25-Sep-13	India’s Income Tax Department freezes all assets of Nokia India
9-Dec-13	Nokia India offers that if the asset freeze is lifted, so that the sale to Microsoft can proceed, it will transfer all proceeds to an escrow account containing a minimum of Rs 2,250 crore, as security for the tax claim
12-Dec-13	The Delhi High Court agrees to unfreeze Nokia India’s assets in return for the deposit of Rs 2,250 crore into an escrow account[3]
	As conditions for doing so, the Court requires that Nokia provide:
	1) a parent company undertaking amounting to Rs 3,500 crore on behalf of Nokia India
	2) unconditional undertaking on its own behalf and commitment to pay any tax demands before exhausting all available legal remedies
5-Feb-14	The Delhi High Court amends its December 12, 2013 ruling, requiring Nokia to commit to pay taxes for which it is not legally liable and waive its international rights to defend itself
12-Feb-14	Nokia India announces it will appeal the decision of the Delhi High Court to the Indian Supreme Court
Feb-14	Nokia India receives a Rs 2,400 crore (€300m) sales tax bill from tax authorities in Tamil Nadu, who claim that handsets manufactured in Chennai during FY 09/10- 11/12 were not exported but were sold in Tamil Nadu
14-Mar-14	India’s Supreme Court dismisses Nokia India’s asset freeze appeal, allowing the Delhi High Court order to stay in force
21-Apr-14	Nokia confirms that the Chennai factory will be excluded from the Microsoft deal, due to the asset freeze imposed by the Income Tax Department
25-Apr-14	Nokia globally completes the sale of substantially all of its Devices & Services business to Microsoft.
29-Apr-14	The Madras High Court orders the Tamil Nadu tax authorities to reconsider their sales tax claim against Nokia India. The Court asks Nokia to provide Rs 240 crore, or 10% of the disputed tax demand, as a deposit within eight weeks as a precondition for the two sides to discuss the claims
14-May-14	Nokia announces that it has sent a letter to Indian Prime Minister Dr Manmohan Singh under the Finland-India Bilateral Investment Treaty (BIT) seeking amicable resolution of the tax dispute
6-Oct-14	After Microsoft ends its transitional services agreement (TSA) agreement (for Sriperumbdur facility), Nokia announcs from November 1 operations will be suspended
10/31/2014	The last working day of the Chennai factory

Microsoft, which kept Nokia brand to only feature phones while selling smartphones under Lumia, acquired Nokia device business for USD 7.2 billion and the deal was closed in April 2014. However, as the Delhi High Court was in the process of hearing on the Nokia tax dispute ,Microsoft, eager to settle the acquisition row without any hassles, has been  keeping its fingers crossed. The software major does not want to meddle with the legal tangle Nokia currently is in and wants to stay away from row till the issue is settled. “As this is a Nokia dispute,Microsoft will not issue a comment on the matter,” Waggener Edstrom, the global communication consultant who handles Microsoft media account, commented.

An analyst, specialising in mergers & acquisitions, indicated that it is pertinent for a global company like Microsoft to stay away from the heat generated during the legal recourse regarding Nokia’s tax liabilities. There are certain binding rules as far as agreements are concerned. “Obviously they would want Nokia to come to the table with clean hands or else the Chennai assets would be kept out of the agreement for time being.” Under the terms of the agreement of the deal Microsoft is to transfer close to 32,000 people, including 4,700 people in Finland and 18,300 employees directly involved in manufacturing, assembly and packaging of products worldwide to its own company rolls.

Retrospective amendments to tax laws brought in 2012 by the then UPA government forced the Nokia plant to shut down in November 2014, causing more than 15,000 direct employees to lose their jobs. Nokia, once an iconic mobile handset maker, in 2014 decided to shut down its plant at Sriperumbudur, near Chennai. The company said it had decided to stop production at its Chennai plant from November 1, 2014, in the absence of orders from its new parent firm (Microsoft), which terminated the mobile purchase agreement. The Nokia factory at Sriperumbudur in Tamil Nadu  remains one of the largest manufacturing facilities for mobile phones in the world.

Disclaimer / Caveat: Whatever I have stated is publicly available information and does not represent the view of the firm I work for.

(This post is not copyrighted and may be reproduced freely with appropriate attribution of source)

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[1] Withholding taxes are a government’s way of making sure that the proper taxes are paid on an item by way of either withholding or deducting the relevant tax amount from an individual’s or an enterprise’s income. They are of particular note to international companies doing business with India yet without a presence there, as some services provided to Indian customers can be subject to withholding tax. They may also impact on foreign subsidiaries of international companies in inter-company agreements.

[2] DTAA or Double Taxation Avoidance Agreement is a tax treaty that India has with 65 other countries. These agreements give the right of taxation in respect of the income of the nature of interest, dividend, royalty and fees for technical services to the country of residence. However, the source country is also given the right but such taxation in the source country has to be limited to the rates prescribed in the agreement. The rate of taxation is on gross receipts without deduction of expenses.

[3] An escrow account is a temporary pass through account held by a third party during the process of a transaction between two parties.