How do multinational companies reduce their tax burdens? A popular option where there is an operating subsidiary in a country with high taxes is to have that unit reduce its profits by paying royalties or licence fees to an associated company in a place where taxes are lower.
It’s a common practice, although the legitimacy of the tactic depends in part on whether licenced intellectual property has actually been used by the subsidiary in question.
This is the issue at the heart of the current case against Xiaomi in India, which last week saw the authorities freeze Rs55 billion ($726 million) from the Chinese smartphone maker’s local bank accounts in a dramatic dispute.
According to the Ministry of Finance’s Enforcement Directorate, Xiaomi India has been remitting money “in the guise of” royalties to three offshore affiliates since 2015 in contravention of foreign exchange laws. “Xiaomi India procures the completely manufactured mobile sets and other products from the manufacturers in India. Xiaomi India has not availed any service from the three foreign-based entities to whom such amounts have been transferred,” the Enforcement Directorate’s statement said.
Xiaomi countered that the royalty payments were made for “in-licenced technologies and intellectual property used in our Indian version products”. It added: “It is a legitimate commercial arrangement for Xiaomi India to make such royalty payments.”
Xiaomi is the leading smartphone vendor in India, controlling a 24% market share, according to the most recent figures from Counterpoint. And while its brands (Mi and Redmi) have traditionally targeted the low to middle budget smartphone buyer, its more expensive offerings are starting to gain ground in the premium category, which has traditionally been dominated by Apple and Samsung.
Xiaomi is operating in India against a backdrop of political tensions between New Delhi and Beijing that worsened in June 2020 after two dozen soldiers, mainly Indian, were killed in clashes on a stretch of disputed Himalayan border.
Since then, India has blocked some 300 Chinese apps and there have been various calls for local consumers to boycott Chinese goods.
Xiaomi’s current problems began in December last year when the tax authorities raided its offices, along with those of other phone Chinese companies Oppo and One Plus, as well as their suppliers. Prior to that the Indian offices of Chinese phone maker ZTE had been raided, while in February this year the premises of Huawei were also the target of a surprise swoop by tax authorities.
After the initial raid Xiaomi was ordered to pay $88 million in missing import duties. Then in April Xiaomi India’s former managing director, now global vice president, was summoned to assist with investigation.
Some have posited that the investigations were driven by geopolitical tension and that India is targeting Chinese companies as a way of showing its displeasure over changes to the status quo. Others suggest that New Delhi might want to reduce the Chinese share of the smartphone market to make way for local brands.
Part of that could be a battle over distribution, with the Indian government said to have made unofficial requests to favour local sales companies over Chinese ones.
“Since there is no legal framework to bar such operations, the government has unofficially conveyed its stance to the brands. Meanwhile, it is developing a legal framework which may include a clause around working with distribution companies that belong to countries sharing borders with India,” the Economic Times wrote.
The Indians are also compiling a list of trusted sources for telecoms equipment in a bid to keep Chinese players such as Huawei and ZTE out of critical areas of their telecoms networks.
Meanwhile, Xiaomi’s shareholders should be concerned by threats to its Indian market access, warns the Financial Times Lex column. “The Indian market is crucial for growth. About 40% of the population still do not own a smartphone. Sales rose 27% last year, a record pace, even as the pace slowed globally. Shipments of newer 5G models rose more than 500%.”
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