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

By Arpan Chaturvedi and Aditya Kalra

NEW DELHI, Feb 25 (Reuters) - 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."