Xiaomi challenges India tax authority over tariffs on royalties in closely watched case

Xiaomi has challenged an Indian tax ruling that said the company evaded $72 million in tariffs on royalty payments, according to legal documents, a dispute that the Chinese company and lawyers say is a test of the country’s legal framework for contract manufacturing.

Xiaomi, a major player in the Indian smartphone market, has for years had its contract manufacturers in the country import parts from China, pay customs duties and then assemble the devices.

But in November, an Indian tax tribunal ruled those import values had been undervalued for at least three years leading up to 2020 as they failed to include the 2% to 5% royalties that Xiaomi paid to foreign firms like Qualcomm for using their technologies in components.

In a Supreme Court challenge, which Reuters is first to report, Xiaomi argued that the tax tribunal erred by saying it was the “beneficial owner” of the components while requiring it to pay tax on the royalties. Xiaomi has asked that the ruling be overturned.

The implications of the tribunal’s ruling are far-reaching as they indicate “an implicit mistrust of the entire contract manufacturing industry,” Xiaomi said in a filing dated January 15, which is not public but was reviewed by Reuters.

The tribunal decision “grievously injures the established practices of (the) manufacturing sector.”

Xiaomi, Qualcomm and India’s customs department did not respond to requests for comment.

PRECEDENT-SETTING CASE

Xiaomi’s former contract manufacturers, Flextronics Technologies India, a unit of U.S.-listed Flex and Bharat FIH, a unit of Taiwan’s Foxconn are also opposing the tax tribunal’s decision at the top court, according to two people with direct knowledge of the matter and the court’s online listings.

Flex declined to comment and Foxconn did not respond to a request for comment.

Tax lawyers say the case is being closely watched by global investors and companies who have bet big on India.

A ruling in favour of Indian authorities could increase scrutiny of the royalty agreements that many importing companies have in sectors including pharmaceuticals, autos and manufacturing, lawyers said.

“The Supreme Court ruling will be widely significant as it will specify the powers of Indian customs,” said Tarun Jain, a New Delhi-based tax lawyer.

“If upheld, it can empower authorities to seek taxes on other related payments made by companies who may be exercising effective control over goods being imported by their partners.”

Luring foreign companies like Apple to manufacture in India has been a key priority of Prime Minister Narendra Modi in recent years. Volkswagen and Samsung are also contesting sizeable Indian import tax demands in court, an issue that has soured investor sentiment.

XIAOMI’S HEADACHES

According to Indian law, the customs tax demand of $72 million could rise to more than $150 million with interest and penalties if Xiaomi India loses in court. That could put a strain on the company as its profits were $31.7 million in the 2023-2024 financial year.

On top of that, around $610 million of Xiaomi India bank funds have been frozen by a federal financial crime-fighting agency, the Enforcement Directorate, since 2022 due to allegations of illegal remittances. The company has denied the allegations.

Counterpoint Research data showed Xiaomi’s India smartphone market share plunged to 12% in December from a high of 31% in early 2018.

In a hearing on Monday, Xiaomi’s lawyer told the Supreme Court the tribunal’s decision will “lead to chaos.”

Its court filing showed Xiaomi will argue import taxes are to be paid by importers – in this case contract manufacturers – and its royalties are not linked to those imports and therefore should not be taxable.

In November, the Indian tax tribunal said Xiaomi “indulged in deliberate suppression of facts” and royalties need to be taxed as the company is paying for technology that is critical to the imported parts.

During Monday’s hearing, the court told the Indian government to respond to Xiaomi’s plea that its royalties should not be taxed.