The exact figures are a bit of a commercial secret, but Apple reportedly makes between $150 to $250 per iPad that Chinese assembler Foxconn makes for it. Foxconn, on the other hand, makes just a small fraction of this once you take out the cost of the goods it imports as part of the assembly process. A chart by Bloomberg puts Apples margins at 30% in 2012 as compared to Foxconns 1.5%while Apples margins doubled since the iPhone debuted in June 2007, Bloomberg says, Foxconns nearly halved.
Now imagine what would happen, to Foxconn as well as to a host of other Chinese manufacturers, if the Chinese taxman were to slap a transfer pricing case on it and argue that a part of the profits Apple was making was nothing but underinvoicing of exports by Foxconn? Apple would think twice about getting manufacturing done by Foxconn, thats what. Yet it appears thats what the taxman in India is in the process of doing in the case of the mobile phones exported by Nokia from its assembly operations near Chennaiwhile a formal tax notice is yet to be served, those in the know say the tax demand is likely to be in the region of R13,000 crore.
The big difference between Foxconn and Nokia, of course, is that while the latter is a subsidiary of the parent Finnish firm, there are no ownership ties between Apple and Foxconn, but the principle is the same: how do you impute a fair value to the work done by a Foxconn or a Nokia India on an item that is exported? Should this just be done by, for instance, looking at rates charged by different local industriesin this case, assembly units for electronicsand using them as a benchmark for calculating an acceptable arms-length price?
Every case differs from the other, and transfer pricing is a hotly debated subject all over the world, but any tax demand has to be seen in the context of the impact this will have on Indias desire to grow as a manufacturing base. Given that, going by the budget documents, India gave R2,12,167 crore of excise duty concessions to the manufacturing sector in FY12, and another R51,292 crore of concessions to corporates in general, its a fair assumption that India does want to grow its manufacturing. Which is why, as FE has argued in the past, the fact that there has been an 85% increase in the number of transfer pricing demands by the taxman in FY12from R1,220 crore in FY06 to R24,111 crore in FY11 and to R44,532 crore in FY12is deeply disturbing.
In the case of Nokia, apart from the transfer pricing, there are elements of the Vodafone retrospective case as well. Nokia has been issued a tax demand of R3,000 crore for not paying taxes on the software it was importing from its Finnish parent over the years. The problem here is the explanatory memorandum of the budget (page 20 for those whore interested) itself says Some judicial decisions have interpreted this definition in a manner which has raised doubts as to whether consideration for use of computer software is royalty or not; whether the right, property or information has to be used directly by the payer or is to be located in India or control or possession of it has to be with the payer
Having said this, the Budget then says it proposes to amend the income tax act to remove any scope for confusion but, and heres the Vodafone link, these amendments will take effect retrospectively from 1st June, 1976 and will accordingly apply in relation to the assessment year 1977-78 and subsequent assessment years. The taxman has done well to issue clarifications, but going all the way back to 1976?
But lets go back to the Foxconn case. If the Chinese taxman was to say Foxconn (and Foxconn would bill Apple for it) was to pay a tax on the software it got from Apple for putting into the iPhone or the iPad, this would increase the costs of manufacturing in Chinathe Chinese taxman probably treats the software as yet another component that is being imported and, since the final product is being re-exported, there is no tax levied on it.
In each case, whether it is Shell, Nokia or Vodafone, or the countless others, the real issue that needs to be kept in mind is the costs of this tax stridencythis is why the Parthasarathi Shome committee was against retrospective amendments; this is why, despite everything, India has kept the Mauritius route open. And lets make no mistake, this is about the costs of doing business in India, it is not about whether it is morally okay or not to avoid paying taxes. The fact of the matter is India does not charge taxes on all thingsit gives tax breaks for those producing in SEZs because it thinks this will stimulate production, it gives tax breaks to individuals on buying insurance because it thinks this serves a social purpose; all told, in FY12, tax breaks worth R3,93,000 crore were given. So if a Vodafone or a Nokia did not pay taxes, this is because the law allowed it, and the law allowed it because it wanted their business. India wishing to review the law is its business, as is relooking the way MNCs are pricing their exports, but there is an economic impact of all this. It will be interesting to see if the budget will try and address some of these concerns.