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http://mrunal.org/2014/05/economy-nokia-tax-row-royalty-payment-chennai-plant-finland-dtaa-microsoft-takeover-unicitral-tdswithholding-tax-explained.html

[Economy] Nokia Tax Row: Royalty Payment, Chennai Plant,

Finland DTAA, Microsoft Takeover, UNICITRAL, TDS,
Withholding Tax explained
1 year
Ago

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.=> 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

Royalties: TDS (Tax deduction at source)

25%

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 interchangeablysometimes 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.

2006

Nokia starts Factory in Tamilnadus SriPerumbudur SEZ 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
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

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
excuse

document proofs = nearly 16 lakh pages. 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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