Thread by @zerodhamarkets

There’s a new battle brewing—Volkswagen vs. India’s revenue department—and it's turning messy. In September 2024, Indian tax authorities issued Volkswagen a staggering $1.4 billion tax notice, accusing the automaker of underpaying import taxes for years. 🧵👇

As a strategy, Volkswagen imports car parts, assembles them in India, and sells the finished vehicles. Indian authorities, however, claim Volkswagen found a way to avoid paying the higher import tax rate on these imported car parts. Volkswagen insists it has merely been following the rules.

The Indian authorities say that if a car company imports most of a vehicle in CKD (Completely Knocked Down) form, it faces a steep 30-35% import duty. However, if companies import individual car parts separately and manufacture the car in India, they qualify for a lower 5-15% tax rate.

The government alleges that Volkswagen deliberately splits up shipments to bypass the higher tax bracket. Up to 1,500 parts per car were ordered in different batches to avoid this higher tax. Essentially, India is accusing Volkswagen of exploiting a loophole in tax rules.

Volkswagen defends itself against the tax allegations by insisting it has never imported full car kits to avoid taxes. Instead, the company argues, it separates car part shipments for logistical reasons. They liken it to ordering parts of a chair individually, not as a disassembled unit, which attracts a higher tax rate.

In 2011, Volkswagen claimed it had informed the Indian government about its “part-by-part” import strategy. The authorities provided clarifications that this approach was compliant with tax rules. Now, they've reversed their stance, accusing Volkswagen of using this setup to dodge taxes.

Volkswagen argues a sudden policy reversal can erode trust in India’s business environment. The company described the tax demand as damaging to the reputation of India’s "ease of doing business” initiative, cautioning it may make global companies reconsider their investments.

Volkswagen operates in India under Skoda Auto Volkswagen India, managing brands like Volkswagen, Skoda, Audi, Porsche, and Lamborghini. As part of its “India 2.0” project, Volkswagen has committed €1 billion to designing cars specifically for Indian buyers—models like the Volkswagen Taigun and Skoda Kushaq are products of this initiative.

Despite merging its operations under Skoda Auto Volkswagen India to fortify its presence in the highly competitive Indian market, VW holds only about 2% market share. With reported sales of $2.19 billion in 2023-24, yet profits of just $11 million, this hefty tax notice could potentially derail Volkswagen's plans in India.

Volkswagen's current tax dispute echoes the infamous 2007 Vodafone tax case in India. Despite the transaction happening overseas, Vodafone was slapped with a $2 billion capital gains tax after acquiring a controlling stake in an Indian telecom firm. The telecom giant fought back, winning the case in India's Supreme Court in 2012.

Despite Vodafone's victory in India's Supreme Court, the government retroactively changed tax laws, making Vodafone liable. This action provoked global investor backlash and tarnished India's business reputation. It took an international tribunal ruling and nearly a decade for India to repeal the retrospective tax law in 2021. However, the damage to Vodafone's financial status was already done.

Volkswagen isn't alone in its struggles in India. Other automakers have had their fair share of challenges too. Nissan found itself in a $770 million tax dispute with the Tamil Nadu government in 2018. In 2021, Ford, after years of regulatory hurdles and losses, ceased operations. Tesla, too, has repeatedly delayed its entry into India due to high import taxes on electric vehicles.

These cases paint a clear picture: while India promotes investment with slogans like “Make in India” and “Ease of Doing Business,” foreign companies often find themselves blindsided by shifting policies and tax disputes.

The tax issue threatens Volkswagen's operations beyond the financial aspects. After the tax notice, Mumbai customs temporarily blocked over 50 shipments of spare parts for Volkswagen's luxury brands, causing disruptions in supply chains and delays at dealerships. Although these shipments were eventually released, the harm to Volkswagen's supply chain has been done.

Volkswagen is taking its massive tax dispute to the Bombay High Court, with a hearing scheduled for February 5th. The automaker aims to overturn the tax notice, in hopes of salvaging its long-term plans in India.

This case extends beyond Volkswagen; it could impact foreign investments in India. If India doesn't provide a stable and predictable regulatory environment, it may deter other foreign companies from making significant investments in the country.

India's goal of becoming a global manufacturing hub is heavily influenced by its handling of disputes like Volkswagen's tax issue. Will history repeat itself with another Vodafone-like debacle, or will the government make efforts to reassure investor confidence? The outcome holds significance for India's future investment landscape.

You can watch the episode on YouTube, read on Substack, or listen on Spotify, Apple Podcasts, or wherever you get your podcasts. All links here: thedailybrief.zerodha.com/p/indias-fmcg-…