India's financial-crimes watchdog has seized three-quarters of a billion dollars in the bank accounts of top-selling smartphone maker Xiaomi (XIACF) and HK:1810.
It alleges the Chinese company, the market leader for phone sales in India, has been illegally sending money out of the country in violation of the country's strict currency controls.
The Directorate of Enforcement has claimed 55.5 billion rupees (US$725.8 million) from the accounts of Xiaomi Technology India, issuing a statement that the company has been sending money to its parent under the guise of fake royalty payments, and misleading banks about why it was remitting the money.
Xiaomi responded on social media, saying it believes its royalty payments and statements to the bank are "all legit and truthful." But it adds that the company is working closely with the authorities "to clarify any misunderstandings." Its premises had last December been raided by tax authorities.
Xiaomi is the world's third-largest maker of smartphones, according to figures from Counterpoint Research, selling more units than anybody other than Apple (AAPL) and Samsung Electronics KR:005930. As recently as Q2 2021, it was outselling Apple and sat in second place.
It is also the market leader in India, capturing 21% market share in Q4 2021, again according to Counterpoint. Xiaomi sells its flagship phones under its own name, has a cheaper line under the Redmi label, and is also casting itself as a lifestyle brand, with three lines of TVs and laptops.
Under the Mi brandname, Xiaomi sells many of the products you'd find at an Apple store, and then some: earbuds, smart speakers, smartwatches, wireless chargers, home-security cameras and even robot vacuum cleaners and electric scooters.
The directorate, the financial-investigation agency for India's Department of Revenue, chases down violations of India's money-laundering and foreign-exchange laws.
It alleges that Xiaomi's Indian subsidiary has been remitting money out of India to three foreign entities, including Xiaomi itself, claiming they are royalty payments that it owes.
"Such huge amounts in the name of Royalties were remitted on the instructions of their Chinese parent group entities," the regulator alleges. The payment to the other two entities, which are based in the United States, was also for the "ultimate benefit of the Xiaomi group entities."
The watchdog says it is investigating remittances made by the company in February. But Xiaomi has been remitting money out of India since 2015, having set up a subsidiary there the year before.
According to the complaint, Xiaomi India buys manufactured mobile-phone sets from manufacturers in India. It hasn't received any sort of service from the three companies that have received the royalty payments, the watchdog insists. The regulator says the companies have created a "documentary façade" between related entities to remit the money illegally, providing misleading information to the banks remitting the money in the process.
Xiaomi says it has studied the order "carefully," but believes it is compliant with local laws and regulations. "These royalty payments that Xiaomi India made were for the in-licensed technologies and IPs [intellectual properties] used in our Indian-version products," it states. "It is a legitimate commercial arrangement for Xiaomi India to make such royalty payments."
In December, the Indian income-tax department raided more than 20 Indian offices of Xiaomi and rival phone maker Oppo, citing "intelligence inputs" that they have been concealing income and evading taxes. Anti-smuggling operatives a day earlier had raided the Indian factories of Foxconn subsidiary Bharat FIH as well as Dixon Technologies, both of which are contract manufacturers to Xiaomi.
The Indian authorities appear to be questioning why Xiaomi is sending money out of the country to its Chinese parent when Xiaomi India is getting phones made in India and selling them in India. Xiaomi India would however have a technology-licensing agreement with the parent that supplied the technology.
A former head of Xiaomi's business in India, Manu Kumar Jain, was summoned to the Enforcement Directorate in April, with sources telling Reuters that fund flows between Xiaomi India, its contract manufacturers and its parent in China are the subject of the investigation.
Regulatory action has helped reshape the global smartphone market. In fact, Xiaomi has been the primary beneficiary worldwide of the troubles inflicted on Huawei under U.S. sanctions.
Huawei briefly became the largest smartphone seller in the world in mid-2020, capturing 20% share of the global market, surpassing Samsung and Apple. But U.S. trade and sanction restrictions then caused its sales to plummet, to where it hardly registers today outside China. Huawei has since sold off its Honor brand of phones into a separate company.
India has strict capital controls on how much money can be invested into and remitted out of India, rules that have dissuaded many a company from setting up subsidiaries there. Many fund managers run their India-focused funds from locations such as Singapore and Mauritius where they can skirt tough securities laws.
Foreign retailers were only allowed to set up wholly owned subsidiaries in India as of the start of 2018. Prior to that, brands required government approval to own more than 49% of an Indian retail subsidiary. If a foreign entity owns more than 51% of its Indian retail operation, it must source at least 30% of the value of the goods within India. Cutting-edge brands - Apple is often mentioned, although it's starting to make phones in India - could apply for a three-year waiver on local sourcing if they couldn't find local goods.
Unofficially, the Indian authorities have been encouraging Chinese smartphone sellers to use Indian companies for their distribution networks. The companies tend to have set up a network of Chinese-owned partners to sell and ship their goods through India.
Chinese companies have occasionally been singled out for tougher treatment from the Indian authorities in the past. Such corporate crackdowns often occur at times of tension between China and India.
In 2020, India banned 59 Chinese apps including TikTok, WeChat and Weibo, then banned another 161 mobile-phone apps including the dominant Chinese search engine, Baidu Search (BAIDF) .
The Indian government said it wanted answers about whether the apps censor content or take work on behalf of the Chinese government. The bans came after Indian and Chinese troops clashed high in the Himalayas, in a border dispute that left 20 Indian troops dead, with 20-35 fatalities among Chinese soldiers, according to U.S. intelligence sources, although the Chinese only released the names of four 4 dead.
More recently, the income-tax department has searched the premises of Chinese tech companies, telecoms, mining operations, chemicals producers and heavy-equipment makers. They have been looking for evidence of undeclared income and tax evasion, according to government statements.
Xiaomi's shares trade in Hong Kong, where it is a public holiday today in honor of Labour Day. So investors will have the first chance to respond to the news via its U.S.-listed over-the-counter ADRs. Trading in Hong Kong will resume on Tuesday.
(Apple is a holding in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells AAPL? Learn more now.)
