May 26th 2020
The world’s largest technology companies have all faced criticism over their global tax practices. Back home too, tech heavyweights are grappling with the Indian taxman.
Tax planners and tax consultants have a name for that $30 billion in profits and it’s a term that sums up perfectly both the aim of those who set up companies this way, and the result achieved: “ocean income”.
That company was Apple Operations International (AOI), based out of Ireland, a country which, because of its highly corporate-friendly tax laws, has turned into a magnet for the tech world’s heavyweights. AOI, Ireland, incidentally, is the parent company for Apple India.
Apple India itself paid tax of Rs 156 crore to the Indian government in 2011-12, and of the three tech companies’ Indian operations ET Magazine looked at for this story — Apple, Google and Microsoft — it was the one with the least amount of taxes under disputes; only minor amounts in relation to its overall profits for 2011-12 are disputed or demanded by tax authorities.
At the other extreme is Microsoft, which faces over Rs 2,000 crore in tax demands (both service and income tax) across its group companies which operate in India. And Google’s India arm is locked in a dispute with the authorities over Rs 156 crore of tax demands in relation to its 2008 balance sheet.
In its financial statements, Google says that if the government assesses its income in later years in a similar fashion to the company’s 2008 income, its tax ‘impact’ could rise to Rs 480 crore.
The subsidiaries of all three companies in India perform a whole range of functions — from research to customer support to actively marketing to local consumers. As Vikram Doshi, partner, tax and regulatory services at KPMG, points out, tech companies fall along a broad spectrum. At one extreme are those whose operations in India are solely focused on servicing group companies around the world.
“At the other extreme are companies focused on the potential of the domestic market and of targeting consumers here.” In actual practice many companies do both and fall, therefore, somewhere in the middle.
And depending on the market they serve, whether foreign or domestic, and whether ‘customers’ are in-house — that is, other group companies — or people buying iPads, the tax implications vary. Take Microsoft for instance. It operates separate companies in India, each focused on a different line of business. Microsoft India handles marketing for the company’s products, such as Office or Windows 8.
While it focuses on the domestic market, two sister companies (see Big Tech’s India…) focus on servicing group companies. ET Magazine approached Microsoft with a list of questions but there was no response till the time of going to press. Given the range of activities of Microsoft’s India operations, it’s no surprise that the kind of tax notices and disputes it faces span a spectrum.
Take Microsoft India which provides marketing support services to the group’s Singapore arm. It claimed that such services, aimed at drumming up customers in India, qualified as service exports and were therefore tax exempt. The taxman disagreed with the result that the company now faces a total of Rs 347 crore in service taxes due as of 2012. The dispute is in the courts. It’s worth recognising an interesting fact about the ways the MNC tech companies in India earn their revenue.
And while Apple books revenue in India from domestic customers, it buys over Rs 1,148 crore of goods from a fellow subsidiary in Ireland. Why would MNC tech companies in India structure their businesses in such a way as to treat even income from domestic consumers as income earned from overseas parents?
No Permanent Presence?
Google’s tax issues with Indian authorities are about its Adwords advertising service under which a person can buy the right to have their ads displayed on Google when certain text is searched. A florist, for example, might buy the right to have his ads displayed whenever anyone searches for the words ‘flowers’ or ‘birthday’.
From the taxman’s point of view though, here’s what’s important: one of Google India’s roles is to pitch to customers the benefits of buying Adwords on Google — it’s essentially a marketer and distributor for the Adwords program in India, even as the technology infrastructure that makes the Adwords programme possible was developed and is managed elsewhere.
When an Indian customer books an ad, Google Ireland charges Google India a ‘distribution fee’ for each ad sold to an Indian customer— such fees essentially reflect a cost of running and maintaining such infrastructure. And Google India meanwhile, calculates its revenues, net of such fees. Essentially the money goes on a round trip — from the Indian customer to Google Ireland, and then back to Google India, after netting out fees.
The sums involved are substantial. Google India ‘paid’ a distribution fee of Rs 570 crore to Google Ireland, and booked revenues of Rs 337 crore from its Irish sister company in 2011-12 (its unclear how much of this is from the Adwords program).
Indian tax authorities have taken issue with this, and argued, in effect that even that Rs 570 crore should show up in the books of the Indian company and be taxed. If the tax authorities prevail in their view, Google could be forced to stump up as much as Rs 480 crore in taxes and interest across various years.
There’s another twist to the tax complications with Adwords as well — and that’s on the customer’s side.
Tax authorities have claimed that when an Indian customer buys Adwords from Google Ireland, it is required by tax law to deduct tax at source before hand.
In April though, the Income Tax Appellate Tribunal in Kolkata ruled that this wasn’t required, since Google Ireland did not have a ‘permanent establishment’ in India, and under the terms of an India-Ireland tax treaty, no taxes needed to be withheld by the Indian customer.ET Magazine approached Google with a set of queries. A spokesperson responded: “Google complies with the tax laws in every country where we operate.
The reality is that most governments use tax incentives to attract foreign investment that creates jobs and economic growth and, naturally, companies respond to those incentives.
It’s one of the main reasons Google located our international HQ in Ireland. If politicians don’t like those laws, they have the power to change them.
Overall, our effective global corporate tax rate in 2012 was almost 20%.” Even if Google India did have to book all the Adwords revenue from Indian customers, there’s still a problem.
Since the Google site, and the back-end infrastructure supporting it, was not developed by Google India, its undeniable that at least a part of Adwords revenue in India has to be paid to the entity in the Google corporate universe which did so (though that’s unlikely to be Google Ireland).
“The question is: how much in compensation or fee needs to be remitted by Google India,” asks an accountant with one of the Big Four audit firms.
Given that a huge chunk of earnings of MNC tech companies’ India arms are actually revenues from group companies elsewhere, or payments to them, the issue of what accountants call ‘transfer pricing’ is almost bound to arise. The problem arises when two companies, both under effectively the same management, trade goods or services with each other or do any kind of deal.
The ‘price’ at which that deal happens is effectively not a market-determined one, because management can decide which company should ‘profit’ from the deal — and quite often the criterion is to allocate the profits to the company located in a country or region where taxes are lower. In this way, the company in the ‘high’ tax country (like India) would record a loss and hence pay no tax. “When it comes to such intercompany transactions, almost the only issue of relevance is transfer pricing,” points out Doshi.
“Transfer pricing issues are now centre stage when it comes to taxation of such international transactions between two group companies,” agrees Aseem Chawla, partner at MPC Legal. In 2012-13 according to reports, the Indian tax authorities made transfer pricing ‘adjustments’ to the tune of over Rs 70,000 crore, in 3,200 cases, up from Rs 44,500 crore in 1,343 cases a year earlier.
Such adjustments effectively involve tweaking the taxable income earned by an Indian company from an international deal to reflect what the department would consider a ‘fair’ price — this is often based on the principle that there should be arms length relationship between the two companies involved. In other words, what would the terms of the contract be if the two companies were unrelated to each other, and each was trying to get the best terms for itself?
And, interestingly, as a US Senate subcommittee investigation of both Apple and Microsoft showed, Irish subsidiaries hold significant rights to the companies’ intellectual property. “For technology companies, Ireland has been an important jurisdiction in which to house intellectual property rights. The IP protection regime is strong, and in addition, the tax rate is low, making it an ideal location,” says Doshi.
Only the Beginning?
Indeed intellectual property, and how a customer at the retail end pays for it, and who they pay, is the other twist in this tale. A few years ago, Microsoft became the centre of a major tax case, which eventually led to critical changes in law, with retrospective effect. When we buy software such as Windows 8, are we buying a good (like a CD), or are we simply acquiring a licence to use that software, albeit indefinitely? Despite the fact that software buyers sign a licence agreement with Microsoft, when they buy software, thus implying that the company itself thinks of the deal as a licencing agreement, the company actually argued before the taxman in a different way. It claimed that buyers were being sold a copyrighted article, not acquiring a licence.
That licencing actually happened offshore, between various Microsoft entities, in a complicated series of deals. Customers bought the software in India from distributors (not Microsoft itself ), who in turn imported the software from Microsoft Singapore. The key here is how these two different types of revenue are taxed. If a customer is merely buying a good, earnings from it are taxed only if the seller has a presence in India.
If, instead, what we pay is royalty for acquiring a licence to use a copyrighted software, then any payments by Indian customers can be taxed in India before the funds are remitted overseas. Since Indian customers were buying the software not from Microsoft directly, but from its distributors in the country, and since Microsoft USA or Microsoft Singapore does not have a presence in India, there was no question of taxing Microsoft. On the other hand, if the customer was paying a royalty, then tax was implied even if the seller had no physical presence in the country.
The taxman disagreed with this reasoning and so did the Indian government which closed off this avenue of argument by amending the Income Tax Act last year, with retrospective effect. Of all three companies, it is Apple that has the least tax disputes. But that may well not last. Apple’s revenue was Rs 2,003 crore in 2011-12 up sharply from Rs 620 crore in 2010-11. It’s likely to have gone up even further in 2012-13. All this makes it a tempting target for tax authorities hungry for revenue.
Are big tech bluffing India? Are they stealing millions from India and taking the money away?
The Indian approach on the Internet taxation has left much to be desired. India has not yet crystal clearly defined its holistic national approach and perspectives on taxation on the Internet. Further, India needs to distinctly be walking in the path of ensuring that legal entities who are offering their services via the internet in India, whether they are physically present in India or not, would be subject to Indian taxation