Nokia’s factory in Sriperumbudur, Tamil Nadu, once the world’s largest mobile phone manufacturing plant, has been reduced to a vacant piece of land with the company suspending the unit’s operations with effect from November 1, 2014. The closure is the final move in a year-long dispute that started when the income tax authorities raided Nokia’s corporate offices in Gurgaon and the Sriperumbudur facility near Chennai in January 2013. This was followed by Microsoft announcing the takeover of Nokia’s global handset business in April 2014.

Nokia’s rise and fall

In 2004, when Nokia was looking for a location to set up its plant in India, the Tamil Nadu government won the race over many other contenders, including Haryana, Andhra Pradesh, Uttarakhand, Karnataka and Maharashtra, which were competing to convince the Finnish handset major to invest in their state. In April 2005, Nokia entered into an MoU with the Tamil Nadu government to set up its plant in the Sriperumbudur special economic zone (SEZ). It made significant investments in setting up giant assembly plants in which the assembly was done by hand so as to take advantage of cheap local labour. The first batch of mobile phones was shipped out on March 7, 2006.

Alongside, Nokia’s vertical integrators and component suppliers set up their units in the same SEZ. Elcoteq Electronics India Private Limited was the first to come in after Nokia, followed by Foxconn India Private Limited (recently renamed FIH India). Several other suppliers of the Finnish firm, such as Flextronics Technologies, Perlos Telecommunication and Electronic Components India, Wintek Technology India, Laird Technologies India, Byd Electronics India and Salcomp Manufacturing India, followed suit. As a result, in just under 18 months, the Sriperumbudur SEZ became the hardware manufacturing hub of India.

What followed was a series of achievements, both for the company as well as the country. The Sriperumbudur facility became one of the country’s largest foreign exchange earners in the technology sector, exporting phones worth more than $2 billion a year. Nokia’s overall turnover totalled Rs 1.51 trillion between 2005-06 and 2011-12. By 2011, the Nokia complex had produced 500 million units through a low mix/high volume strategy, making it the company’s largest plant by output worldwide.

The decline began with the depreciation of the rupee. This raised the landed cost of the imported component of the cell phone’s cost structure at the facility, which was largely an assembly unit and relied heavily on imported components. While this problem was still manageable, the real blow came with the emergence of smartphones globally. The path-breaking products from Apple and the cutting-edge marketing strategies of Samsung and other vendors hit the demand for Nokia phones, so much so that it reduced the global giant to bankruptcy.

Compounding the company’s problems, the Income -Tax Department raided Nokia’s corporate offices in Gurgaon and the Sriperumbudur facility in January 2013. The department alleged that the Finnish company owed the Indian government Rs 20.8 billion in unpaid taxes. This amount related to payments of about Rs 250 billion that Nokia India had made to its parent company in Finland, Nokia Oyj, for supplying the software used in the handsets manufactured in India. The department considers these payments as “royalties”, which are taxable in India at 10 per cent.

Subsequently, the Tamil Nadu government raised a tax bill of Rs 24 billion as unpaid value added tax (VAT) for assessment years 2009-10, 2010-11 and 2011-12. Together, the two tax cases dealt a serious blow to Nokia’s India operations. The company made several attempts to plead its case, dispute the matter in court and threaten intervention by the Finnish government, but to no avail. Meanwhile, its position in the global arena too continued to decline.

Entry of Microsoft

Microsoft announced that it would buy Nokia’s global handset business for $7.2 billion in September 2013 and the acquisition was completed in April 2014. However, in response to an appeal by the Indian Income Tax Department, the Delhi High Court ruled that the Sriperumbudur plant could not be transferred to Nokia’s new owners. (The Finnish company’s plant in Masan, South Korea, was the only other asset not transferred to Microsoft.) The tax department claimed that Nokia did not have adequate assets to meet the tax bill of over Rs 40 billion. In fact, over time, the initial tax demand of Rs 21 billion has reportedly mounted more than tenfold, inclusive of interest, penalties and various anticipated liabilities.

Consequently, in April 2014, the plant became a contract manufacturing unit for Microsoft, though operating at a significantly lower level. However, this respite too was short-lived for the employees as Microsoft decided against extending any order to the facility post October 2014.

India’s loss is Vietnam’s gain

What started as euphoria, ended in despair, wiping out the entire ecosystem that grew around the plant and leaving a large number of people unemployed. At its peak, along with half a dozen component suppliers, the Nokia SEZ in Sriperumbudur was a source of employment for more than 31,000 persons directly and for scores of others through indirect jobs.

However, post the tax fiasco and the change in market dynamics, which led to the fall of the company, the integrators started shutting down their units in the SEZ. Of the vertical integrators, BYD Electronics has made an exit while others like Foxconn, Salcomp, and Perlos (now Lite-On Mobile) are on their way out. According to reports, Motorola Mobility has suspended its operations while Foxconn and BYD Electronics have offered retirement schemes to their workers. The number of Nokia’s employees was also reduced from 8,000 to 851 by end-October 2014.

In the wake of these challenges, a major cause for concern is that, Like Nokia and its associated vertical integrators, many other companies in the region have winded up their operations, only to start afresh in Vietnam. Bac Ninh in the Red River delta is a typical Vietnamese province. Vietnam’s government is developing the Vietnam-Singapore Industrial Park in the area, just 100 miles from the Chinese border at Guangxi, and equidistant from the Hanoi and Noi Bai international airports. The Chinese and Vietnamese governments are also building a highway between Hanoi and Shenzhen. The ASEAN free trade zone is in close proximity and is also well connected. Labour costs in these Vietnamese provinces are favourable as compared to Shenzhen and almost all of China. All these factors, along with the tax incentives offered by the Vietnamese government, have worked in favour of this region.

Nokia was one of the early entrants into this new zone. Its Bac Ninh plant went online in mid-2013, about the time Nokia’s tax problems started in India. A ramp-up of workers, from 275 to over 10,000, took place by mid-2014. Samsung and Foxconn also set up factories in the region.

India cannot afford to ignore this major flight of investment. According to industry experts, the problems faced by these companies pertain mainly to government policies. Under the Special Incentive Package (SIP) scheme, the government provides an exemption of 20 per cent on capital expenditure during the first 10 years for SEZ units and of 25 per cent for non-SEZ units. However, in 2012, the central government imposed a minimum alternate tax on SEZ developers and units housed in SEZs, offsetting the benefits of the SIP scheme. The termination of the tax holiday in India was a major dampener. It made it costlier for Microsoft to operate the Nokia factory in Sriperumbudur than to source products from Vietnam. Recently, Intel, which was considering setting up a chip manufacturing project in India, chose Vietnam instead as the Indian government could not offer it any concessions.

Reportedly, promises made by the government to some companies at the time they had set up shop in Tamil Nadu have not been kept. For example, the state government has failed to refund the 4 per cent VAT imposed on output from the Sriperumbudur units as promised.

Impact on future investments

Nokia’s decision to suspend manufacturing at its mobile handsets plant is clearly not the best advertisement for the new government’s ambitious “Make in India” plans. On the contrary, it has shaken investor confidence in the country’s income tax system while raising larger questions about India’s attractiveness as a manufacturing destination.