Volkswagen's $1.4 billion India tax tussle rekindles foreign investor fears

India's demand for back taxes running into a record $1.4 billion from Volkswagen, after 12 years of scrutiny, is reigniting concerns that lengthy investigations and litigation could sour the plans of foreign firms in the fastest-growing major economy.

Automakers such as Maruti Suzuki, Hyundai, Honda and Toyota face demands for about $6 billion collectively in disputes on income-tax, customs and other payments that go back years, a Reuters analysis shows.

Although Prime Minister Narendra Modi has been courting foreign investors with promises to simplify regulations and uproot bureaucratic hurdles, lengthy tax investigations remain a sore point, often triggering lawsuits that stretch over years.

In one high-profile incident, telecoms company Vodafone won its case against a $2-billion retrospective Indian tax demand after more than a decade of legal battles with New Delhi, including international arbitration at the Hague.

Now, Volkswagen's move on January 29 to sue India for $1.4 billion in tax that the firm called "impossibly enormous" is making foreign companies jittery.

Tax advisers and lawyers say they are fielding nervous queries from clients about how years-old tax cases could come back to haunt them.

Calls are also growing for an amnesty scheme for cases running for years, as India set a three-year window on February 1 to conclude reviews of customs shipments, but the rule excludes old disputes running into billions of dollars.

"The government clearly recognised this now and redressed it, but it is unlikely old tax demand notices will be given any benefit," said Ameya Dadhich, a tax associate at global law firm DLA Piper.

"Such instances can deter foreign companies from investing heavily in India," he added. "An amnesty scheme will be helpful given that around 40,000 tariff disputes are pending."

India's finance ministry did not respond to queries from Reuters.

Modi wants to turn India into a manufacturing hub, but many electronic and auto companies rely on assembly operations using parts for high-end cars or smartphones imported from markets such as China and Europe, often spurring investigations.

Government data shows total pending arrears of service tax, customs and excise levies stood at nearly $53 billion in November 2024, with a whopping 70% disputed in litigation.

In the category of import tariff, or customs disputes alone, India had made tax demands of $4.5 billion by March 2024, with a third of those pending for more than five years.

One tax adviser and a lawyer for a foreign automaker in India said the Volkswagen news sparked a flurry of calls from companies to gather updates on scrutiny of their shipments, to ensure their imports are classified correctly for tax.

TAX BACKLOG

In a move seen as aimed at placating US President Donald Trump, who once called India a "tariff king", New Delhi cut average tariffs on February 1 to 11% from 13%, though they still exceed those of China, Japan and the United States.

Imports of fully built luxury cars face Indian taxes and levies of about 100%, while the rate is 150% for Scotch whisky and wine.

In the highly competitive auto sector, Volkswagen is not alone in facing tax scrutiny.

Maruti has $2.4 billion of tax demands in dispute, with at least one case concerning transactions from 1986. Volkswagen is locked in tussles over $1.2 billion, apart from the most recent demand, while Hyundai faces $488 million in such demands.

India's appeals tribunal for customs, excise and service tax faced a backlog of 80,000 cases, Sanjay Malhotra, then the revenue secretary, said in 2023. With about 20,000 new cases each year, he said, "We are not able to reduce the backlog."

In the case of Volkswagen, New Delhi accuses it of having imported most parts of 14 models in separate shipments before assembling them locally, paying tax ranging from 5% to 15%.

That strategy circumvented the tax of 30% to 35% payable if the same items were imported in a single shipment as a completely knocked down (CKD) unit.

In its court filing to be heard this month in the financial capital of Mumbai, Volkswagen is blaming Indian officials for their "inaction and tardiness" in taking years to review shipment records, some stretching back to 2012.

Had New Delhi wrapped up its reviews earlier, Volkswagen says, it could have challenged the move or re-evaluated its import strategy, but the tax notice now puts "at peril the very foundation of faith and trust" foreign investors desire.

Two government officials who spoke on condition of anonymity said the slowness of Indian bureaucracy and a lack of adequate documentation from Volkswagen both contributed to the delay.

"Long pendency like in Volkswagen's case has a detrimental effect on business," said Shashi Mathews, head of indirect tax practice at Indian law firm, IndusLaw.

"We are seeing an increase in queries from clients wanting to know the fate of their shipment reviews."