Prior to my years in telecoms, I was involved in commercial investigations and before that I spent a decade working for UK Customs and Excise. So I paid attention as the two worlds of customs controls and telecoms suppliers overlapped amidst Indian media allegations that Chinese telecom vendors have evaded import tax and income tax. Because customs import procedures may not be your strong point, I’ve provided some brief background information below, to help understand the allegations.
India and China are not best friends. Since military actions at their disputed Himalayan border in 2020, India has intensified scrutiny of Chinese businesses in India and banned more than 200 mobile apps from Chinese providers. In response, China’s embassy in New Delhi issued a statement saying that multiple investigations by Indian enforcement agencies into Chinese companies are damaging the confidence of foreign entities investing and operating in the country. According to that statement, such frequent investigation…
…impedes the improvement of the business environment in India and chills the confidence and willingness of market entities from other countries, including Chinese enterprises, to invest and operate in India.
How Do You Value Imported Items?
When goods are imported they are subject to customs controls, one of which is determining if import duty is owed, and if so, how much. Most duty payments are based on value and there are different methods of calculating this, but the simplest and most common is transactional value, which is based on the cost of the item, usually evidenced by a commercial invoice. The following items are usually added to the price you pay (unless they’re already included):
- the cost of transport, insurance, loading or handling connected with delivering the goods to the port of entry
- commissions including sales commissions
- royalties and licence fees
- goods and services provided free of charge or at reduced cost by the buyer
- containers and packing
Together, they form the customs value on the imported goods, the basis for calculating the import duty. Reducing or omitting these amounts results in a lower customs value and, consequently, a lower import duty payment.
What Is Transfer Pricing?
Transfer pricing is the mechanism that governs pricing of internal transactions within businesses and subsidiaries that have common owners. A transfer price is used to determine the cost charged to another division or subsidiary for goods or services. The purpose is to ensure prices reflect the normal open market rate for those goods or services so there can be no manipulation of where taxes are paid by reducing gains in places where taxes are high and increasing them in places where taxes are low. Such transfer pricing rules also apply to intellectual property like patents and royalties.
An Illustration of Transfer Pricing in the Telecoms Industry and Its Impact on Taxes
Let’s say a smartphone manufacturer has two divisions, Division A, which manufactures software, and Division B, which manufactures smartphones. Division A sells the software to other smartphone manufacturers as well as its parent company. Division B pays Division A for the software at the same price that Division A charges other smartphone manufacturers.
If Division A decides to charge a lower than market price to Division B, Division A’s sales or revenues will be lower because of that lower pricing. On the other hand, Division B’s costs are lower, increasing that division’s profits – the financial result for the wider corporation is the same. However, if Division A is in a higher tax country than Division B, the corporation can save on taxes by having Division A charge lower prices and pass those savings on to Division B, boosting its profits, which are taxed at a lower rate. Manipulation of transfer pricing has been used by multinational corporations to evade taxes.
In 2021, India’s tax authorities conducted multiple searches in relation to Chinese mobile communication and handset manufacturers and businesses linked to them. The authorities claimed to have detected unaccounted income worth over INR65bn (USD 820mn) due to the violation of Indian tax laws and regulations.
Oppo India is a subsidiary of a Chinese business that engages in manufacturing, assembling, wholesale trading and distribution of mobile handsets and accessories across India; its brands include Oppo, OnePlus and Realme. Searches were conducted in 2021 to determine if they had evaded tax. Indian media sources recently reported that the Directorate of Revenue Intelligence (DRI) had identified duty evasion by Oppo. Details of the allegation are provided in a press release from the Ministry of Finance.
A show cause notice (SCN) was served on Oppo India after searches of its premises recovered documents indicating some imports had been incorrectly described. The press release says that senior management employees and domestic suppliers of Oppo India were questioned and made voluntary statements accepting that they submitted ‘wrongful’ descriptions to customs at the time of import.
The investigation is said to have established that Oppo India paid royalties and licence fees to various multinational companies in relation to its use of proprietary technology, brand names and intellectual property rights. However, Oppo India had failed to declare these royalty and licence fees when the goods were imported, in violation of the Customs Act and resulting in an alleged duty evasion of approximately USD172mn.
Oppo India is said to have voluntarily deposited the equivalent of USD56mn with the Finance Ministry in relation to the alleged duty evasion. The Finance Ministry’s press release concludes:
After completion of the investigation, a show-cause notice has been issued to Oppo India demanding Customs duty amounting to Rs 4,389 crore (USD550million). The notice also proposes relevant penalties on Oppo India, its employees and Oppo China, under the provisions of the Customs Act, 1962.
The press release doesn’t explain how the alleged duty evasion jumped from USD172 million to USD550 million, but this larger amount may include the penalties proposed for Oppo India, its employees and Oppo China.
The Times of India reported Oppo India’s opinion of the charges.
We have a different view of the charges made in the SCN. We believe it’s an industry-wide issue many corporates are working on. Oppo India is reviewing the SCN received from DRI, and we are going to reply to the notice, presenting our side, and will be working further with the related government departments.
In February 2022, Business Today reported tax officials had conducted searches at multiple Huawei premises as part of an investigation. Sources said the officials looked at financial documents, accounts and company records to determine if there was tax evasion. Huawei said its operations in the country were “firmly compliant” with the law.
We have been informed of the visit of Income Tax team to our office and also of their meeting with some personnel. Huawei is confident our operations in India are firmly compliant to all laws and regulations. We will approach related Government departments for more information and fully cooperate as per the rules and regulations and follow the right procedure
On 8 July, the Economic Times reported that Huawei’s Indian business had been accused of repatriating large dividends (USD93mn) to its parent company and, consequently, reducing its taxable income in India. In the reports I saw, it was noticeable that none of the reported accusations claimed that the dividend payments were in breach of Indian tax law or regulations.
India’s tax authorities froze Huawei’s bank accounts in February after conducting searches of their premises. Huawei denied any wrongdoing and, as you might expect, made its own applications to the courts. Lawyers for both parties are now batting the issue back and forth in the High Court. Tax officials are reported as complaining that Huawei has obstructed their investigation by:
- not producing books of account;
- providing a dump of transaction records which didn’t tally with filed accounts; and
- failing to give access to the email of the Chief Financial Officer who was the decision-making authority on transfer-pricing issues.
An affidavit from the tax authorities said Huawei’s petition to the High Court is…
…a ploy raised on frivolous grounds just to obstruct departmental proceedings and to avoid consequential payment of taxes.
They also claimed to possess “incriminating material” against Huawei, but failed to produce the alleged material or summarise its content.
Multiple media sources reported that on 5th July 2022 India’s Enforcement Directorate conducted searches of over 40 premises across the country as part of a money laundering probe into Vivo and related firms. The action seems to have resulted from an investigation into one of Vivo’s distributors, where it is alleged that Chinese shareholders in that business forged their identify documents.
Various reports suggest this alleged forgery was part of a scheme to launder funds using shell or paper companies and some of the criminal proceeds were diverted abroad, and to other businesses, in order to bypass Indian rules and regulations. Although the investigations have been conducted under the Prevention of Money Laundering Act and reports refer to “proceeds of crime”, nobody has specified the crime, so my assumption is that the issues are also related to duty and tax evasion. Business Today assessed that Vivo India’s aggregate revenue from 2017 to 2021 was nearly USD15.5bn, and that Vivo India transferred nearly USD7.7bn to its Chinese parent company during that time.
NikkeiAsia reported that the Chinese directors of the Vivo distributor left India in 2018 and 2021, having set up 22 companies which were alleged to have transferred large amounts of funds to Vivo India. In January, Vivo was ordered to pay USD88mn in import taxes allegedly owed for the period from 2017 to 2020. In April, the anti-money laundering agency seized USD730mn after a probe found that India’s strict currency laws had been broken when money was transferred to three foreign entities. NikkeiAsia says India’s money laundering agents seized assets including 2kg in gold bars and 119 bank accounts with a balance equivalent to USD58mn.
Sources told Business Today:
The agency is investigating why Vivo India declared profit as expenditure in its balance sheet and transferred substantial sums of money to China
Vivo has said that it is cooperating with authorities and is committed to full compliance with Indian laws.
Xiaomi India sells mobile phones using the Mi brand. These phones are either imported by Xiaomi India or assembled in India from imported parts and components made by contract manufacturers. Mobile phones that display the Mi brand which are made by the contract manufacturers are sold exclusively to Xiaomi India.
In January 2022, a Ministry of Finance press release detailed an investigation initiated by the DRI against Xiaomi India and its contract manufacturers. During the investigation, searches led to the recovery of documents which showed Xiaomi India was paying royalty and licence fees to Qualcomm USA and to Beijing Xiaomi Mobile Software Co. Ltd. One of the directors of Xiaomi India confirmed these payments.
The investigations showed that royalty and licence fees had not been declared in the transaction value of the goods imported by Xiaomi India and its contract manufacturers. Three show cause notices were issued to Xiaomi Technology India Private Limited for recovery of duty amounting to INR6.3bn (USD80mn) for the period beginning April 2017 to the end of June 2020.
Business Today reported Xiaomi’s response.
These royalty payments that Xiaomi India made were for the in-licensed technologies and IPs used in our Indian version products. It is a legitimate commercial arrangement for Xiaomi India to make such royalty payments. However, we are committed to working closely with government authorities to clarify any misunderstandings.
ZTE Corporation supplies telecommunication network equipment, terminal equipment and software to Indian telecom operators and its subsidiary, ZTE Telecom India Pvt Ltd, provides installation, commissioning and testing services for that equipment. ZTE appears to be a little further down the road than some of the other Chinese vendors and has had made some progress at the High Court.
ZTE has been fighting income tax assessments for periods including 2004-05, 2009-10, 2016-17 and 2017-18, with their cases proceeding from the Income Tax Appellate Tribunal to the High Court. As a result of multiple actions and appeals, the High Court has highlighted a number of key questions, including:
- Was an assessing income tax officer justified when adopting different rates of attribution of profit to those defined in the Indo-China Double Taxation Avoidance Agreement?
- Can taxable income derived from supplies made by a foreign parent company be attributed to the subsidiary in India?
- If so, what should be the rate of attribution of profit?
- Is a Chinese company entitled to adjustment of the expenses against payment to an Indian entity for marketing services?
Business is India is complicated. India’s political relations with China only adds to that complexity. It appears that these tax disputes fall into two categories: import fraud and accounting disputes. Usually I want investigations to “show me the data” but that approach will not work because there isn’t any verified data in the public domain. So who is telling the truth? India is trying to maximise its tax revenue and smartphone manufacturers are trying to maximise their profits. My guess is that neither side is telling the whole truth.
Show Me the Revenues
India’s tax officials are under pressure to find more money for the nation’s coffers. They appear to have identified significant underpayments in relation to import valuations and transfer pricing. The fact that appeals have been at least partly upheld in decisions made by tax tribunals and the High Court suggests some assessments have been unfounded or excessive.
Other nations will look at the Indian reports and then check if their smartphone importers are declaring the correct values at import. If they have not, then they should.
If the media’s reporting of these stories is taken at face value, then Oppo and Xiaomi have excluded licence and royalty fees and consequently underdeclared their import values. To reiterate, Oppo stated:
We have a different view of the charges made in the SCN. We believe it’s an industry-wide issue many corporates are working on.
This could be interpreted as Oppo’s way of saying they are only guilty of adopting the same business practices as their rivals.
Whilst Vivo has been accused of money laundering and foreign exchange violations, it is not clear whether it is also suspected of underdeclaring its import values. Vivo and Oppo are owned by the same Chinese parent, BBK Electronics Corporation, the second largest smartphone manufacturer in the world. I would expect an organisation of that size to understand customs regulations. Vivo said it is “committed to full compliance with Indian laws”. That is not the same as saying they fully comply with Indian law already.
The allegations against Huawei and ZTE allegations are harder to nail down. This is partly due to the lack of detailed reporting and partly due to uncertainty surrounding the issues. Based on the information available, it is hard to tell whether the Indian authorities are alleging underpayment of tax, tax avoidance, tax evasion or some combination thereof.
Telco Risk Assessments
Where do supply chain risks sit in your risk assessment? If customs shut down your major supplier and began investigating the others it could punch a massive hole in your supply volume. Do you know if key suppliers are operating lawfully, and have you considered what mitigations may be available?