How a Volkswagen software became the centre of a $1.4 billion tax dispute in India | Company Business News-OxBig News Network

Mumbai: At the heart of a $1.4 billion tax dispute between Volkswagen Group and the Indian government lies a piece of enterprise software, which the German group uses to source car parts from the across the world.

The carmaker said in a court petition that according to the government, instead of importing completely knocked down (CKD) kits paying 35% duty, Skoda Auto Volkswagen India Pvt. Ltd (SAVWIPL) used its software NADIN to break down vehicle orders to components and sub-assemblies. These were then imported at a lower duty of 5-15%, and assembled locally to finished vehicles. Mint has seen a copy of the petition filed in the Bombay High Court.

CKD implies importing all components of a car in an unassembled state, which can then be put together to get a functional vehicle.

The carmaker moved the Bombay High Court after the government demanded customs duty at CKD rates on these items imported over the last 12 years. Mint has seen a copy of the petition, where the company says it uses NADIN worldwide to track demand and plan production, which the taxman has misconstrued as a means to circumvent tax laws.

Here is how it works: Once a customer orders a car, the dealer feeds its details into the software. The company’s production planning team then uses this information to plan how many cars to make in a given period. The software then breaks down the order into constituent parts, and the carmaker orders them from suppliers, many of whom are based in Germany, the Czech Republic and Hungary. Both imported and locally made parts are put together at its Aurangabad factory to make the finished vehicle.

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This is where the difference of interpretation with the tax authorities arises. The carmaker’s petition says the taxman has incorrectly interpreted the software as a means to break down the order for a car into separate parts, which are ordered from hundreds of suppliers around the globe, to the same effect as ordering CKD kits, to save on custom duty.

The tax notice to SAVWIPL on 30 September 2024 challenges SAVWIPL’s classification of parts and components imported for its Aurangabad factory. The government says these imports should be classified as CKD kits—unassembled motor vehicle parts—for cars produced between March 2012 and July 2024. SAVWIPL’s plea on 29 January challenges the notice by customs authorities asking the automobile company to explain why its provisionally assessed bills of entry (BOEs) for importing goods between March 2012 and July 2024 should not be reassessed as CKD kits. The notice also proposes to impose a customs duty of approximately ₹11,526 crores (approximately $1.4 billion) along with interest and to confiscate the imported goods.

SAVWIPL’s defence

The company’s petition says since 2001, SAVWIPL has been importing parts and components for vehicle assembly in India, and the company transitioned to a “part-by-part” import model since 2003, in which parts and components are sourced from various global suppliers for local assembly. SAVWIPL has argued this is a it is common practice in the automotive industry to use such software for production planning.

“Merely on an allegation that parts and components are imported based on sales projections of a motor car at a given period of time, it cannot be assumed that the imports are of complete motor cars in CKD form and not parts,” the SAVWIPL petition said, denying the use of NADIN has any bearing on the classification of parts being imported.

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Prateek Bansal, partner for taxation at White & Brief Advocates & Solicitors, said the key issue is whether the software’s functionality aligns with the legal definitions and requirements of CKD imports. “Use of centralized software platforms like NADIN can significantly impact the interpretation of tax compliance in cases involving CKD imports. Tax authorities may argue that such systems streamline the ordering process in a way that effectively results in the importation of complete vehicles, albeit in separate parts, which could be seen as a method to circumvent higher import duties associated with fully assembled vehicles,” he said.

The SAVWIPL petition said parts and components are neither imported in a single consignment nor in and around the same time. The majority of imported parts are of a general nature and are interchangeably used at the plant for production of various models. Various parts (e.g., exhaust system, steering wheel, tyres, etc.) are locally procured and not imported. Certain parts (axles, door panels, engines of certain models) are manufactured in the plant, and there is no one-to-one correlation between the parts imported versus the number of cars manufactured. None of the above would be true if cars were imported as CKD kits instead of parts and components, it said.

“Through use of such software, dealers of the Skoda, Volkswagen, and Audi brands merely communicate the orders placed by end-customers,” the company argued, rejecting the authorities’ argument that its imports are tied to sales projections or customer orders. SAVWIPL emphasized that the parts are procured based on a pre-determined Minimum Order Quantity (MOQ) and do not have a 1:1 correlation with production.

Shashank Shekhar, partner, DMD Advocates, said the findings by tax authorities should be based only after examination of relevant facts and evidence, and undue weight should not be given to any single fact, like the use of software. “Since the issue has surfaced, it may be prudent to holistically introspect the entire process of import and manufacture/assembly,” Shekhar said.

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SAVWIPL also pointed to finance ministry note in March 2011, which it claims clearly distinguishes between CKD kits and standalone parts. SAVWIPL believes that this clarification should govern the classification of its imports and make the SCN’s assessment invalid. SAVWIPL has sought to reinforce this clarification in its petition before the HC.

The plea requests the HC to prevent the commissioner from proceeding with the notice and to quash it. It has also sought a declaration that standalone imports of parts and components should not be considered as CKD kits for customs duty purposes. The company has requested an interim stay on the notice’s implementation, halting any action until the matter is resolved in court.

When contacted by Mint, a spokesperson for Volkswagen’s India unit said that it was availing itself of all legal remedies.

“SAVWIPL is committed to operating as a responsible organisation, ensuring full compliance with all applicable global and local laws and regulations. Compliance with regulatory requirements is one of SAVWIPL’s fundamental principles, and we are cooperating fully with the authorities on this matter,” the spokesperson said.

Emails sent to the finance ministry and the Central Board of Indirect Taxes & Customs (CBIC) went unanswered. However, Sanjay Kumar Agarwal, chairman of the Central Board of Indirect Taxes and Customs (CBIC), told The Indian Express in an interview that the investigations started in 2022 and it was generally noticed that the imports were split into multiple consignments, whereas these were falling in the category of a car in CKD condition and the rate applicable to CKD condition was leviable.

Implications for the industry

Industry insiders said SAVWIPL’s claim that using ERP software to streamline production was a standard industry practice not just for carmakers but across all large manufacturing companies. However, they said that the issue here was more complex.

“This is a grey area,” said one senior industry executive who did not want to be identified when discussing a specific company.

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When asked if such litigation could have geopolitical influence, experts said that diplomatic and geopolitical considerations can sometimes influence the resolution of such disputes.

“A notable case involved Vodafone, a British multinational telecommunications company. Vodafone acquired Indian assets of Hutchison Whampoa in an $11 billion deal. The Indian government later demanded $2 billion in taxes from Vodafone, leading to years of litigation. The dispute saw a ruling in Vodafone’s favour by the Supreme Court, followed by a change in law that reimposed the tax demand. Eventually, Vodafone won an international arbitration case against India in 2020,” Bansal said.

Experts believe that the outcome in SAVWIPL’s case could set a precedent for other multinational companies using similar ERP systems for ordering vehicle parts. “If the court rules in favour of the tax authorities, it could lead to increased scrutiny and potential reclassification of imports for other companies using centralized ordering systems. Conversely, a ruling in favor of SAVWIPL could reinforce the legitimacy of using such systems under current tax laws, provided they comply with the established legal definitions and requirements,” Bansal said.