On 13 August 2021, the President of India gave his assent to the Taxation Laws (Amendment) Act, 2021 ("Act") which amends the longstanding controversial retrospective tax law which was brought into effect in the year 2012. The Act has given a go-by to the provisions under the Income Tax Act, 1961 which enabled the tax authorities to impose retrospective capital gains tax on foreign entities selling their shares in India dating back to 1962. The move comes at a time when the Indian government was facing the heat of the ongoing proceedings across multiple jurisdictions instituted for enforcement of a $ 1.2 billion investment arbitral award ("Award"). The rendering of the Award gave a sense of déjà vu as India had faced similar challenges in the famous Vodafone International Holdings case. This article navigates through the aforementioned disputes which led to the scrapping of the old tax law. The article also attempts to comment upon the future of Investor-State disputes in India.
The case of Vodafone International Holdings
In 2007, Vodafone International Holdings ("Vodafone") bought 100% shares of CGP Investments (Holding) Ltd. (CGP) for a sum of approximately $ 11 billion. CGP was a wholly owned subsidiary of Hutchison Telecommunications International Ltd. and had a 67% stake in Hutchison Essar Limited ("Hutchison"). The transaction included the transfer of the telephone business and other assets of Hutchison in India. In September 2007, the Indian tax authorities ("Authorities") raised a demand of INR 7,990 crores against Vodafone for capital gains and withholding tax. The Authorities claimed that the taxable amount should have been deducted at source prior to making any payment to CGP. The demand notice was challenged by Vodafone by way of a writ petition in the High Court of Bombay ("High Court"). The High Court dismissed the writ petition and ruled in favour of the Authorities. Vodafone appealed against the decision of the High Court before the Hon'ble Supreme Court. It was observed by the Apex Court that business entities were allowed to engage in tax planning and arrange their affairs to reduce their tax liability. Therefore, the Hon'ble Supreme Court concluded in favour of Vodafone by holding that the transaction did not amount to transfer of capital assets and did not attract a capital gains tax.
Retrospective tax amendment 2012
In March 2012, the Indian Government amended tax regime to retrospectively tax any transactions from 1962 where shares in non-Indian companies were transferred to an Indian holding company ("2012 Amendment"). The 2012 Amendment further clarified that an asset or capital asset such as shares or interest will be deemed to have been situated in India, if the share or interest derived (directly or indirectly) its value substantially from assets located in India. The 2012 Amendment was introduced to circumvent the Indian Supreme Court's ruling in Vodafone International Holdings B.V v. Union of India1 against retrospective reading of tax law.
Genesis of the Tax Dispute in Cairn's Case
In 2006, Cairn India Limited ("CIL") was incorporated in India as a wholly owned subsidiary of Cairn UK Holdings Limited ("Cairn UK") (collectively "Cairn"). Later in the year, Cairn UK sold shares of the Jersey based wholly owned Cairn subsidiary to CIL as a part of internal restructuring to consolidate its Indian assets. By the end of the year, CIL divested 30.5% of its shareholding through an Initial Public Offering. In 2011, Vedanta Resources Plc ("Vedanta UK") acquired the majority stake i.e., 59.9% in CIL. Subsequently, CIL merged with Vedanta UK's subsidiary, Vedanta Limited in 2017.
Tax Reassessment based on 2012 Amendment
In January 2014, the Indian Tax Department ("ITD") initiated reassessment proceedings against Cairn UK for the 2006 transaction. Based on the 2012 Amendment, ITD passed a draft assessment order on 9 March 2015 which estimated the capital gains tax due from Cairn UK as approximately $ 1.6 billion without applicable interest and penalties. The ITD's assessment order was challenged by Cairn UK before the Income Tax Appellate Tribunal which upheld the capital gains tax but rejected the interest demanded ("ITAT's Order"). The ITAT's Order has been challenged by Cairn before the Delhi High Court (in relation to the imposition of capital gains tax) and by the ITD (in relation to the rejection of interest demanded). ITD passed another draft assessment order against CIL in relation to capital gains tax in relation to the 2006 transaction. The capital gains tax of $ 3.293 billion along with interest of the same amount was claimed as due from CIL.
Arbitral proceedings and other developments
On 10 March 2015, Cairn initiated international arbitration proceedings against India before the Permanent Court of Arbitration ("Tribunal"). Cairn argued that imposition of retrospective tax was contrary to India's obligation to treat investment from UK in a "fair and equitable manner" under the 1994 Bilateral Investment Treaty between India and UK ("India-UK BIT").
The Indian Government sought a stay on the Cairn proceedings but the Tribunal rejected this request. During the pendency of the arbitration proceedings before the Tribunal i.e., 2016 to 2018, ITD seized Cairn UK's shares worth approximately $1 billion in Vedanta Limited. ITD sold part of Cairn UK's seized shares to recover part of the capital gains tax. ITD also seized Cairn UK's other assets in India and dividends due to Cairn UK.
On account of the losses due to seizures by ITD, Cairn UK claimed compensation of approximately $1.3 billion from India before the Tribunal. Cairn argued that compensation was required to restore Cairn to its pre-2014 position i.e., before reassessment of the 2006 transaction.
Arbitral award and enforcement proceedings
In June 2021, the Tribunal Judiciaire de Paris allowed Cairn's application to freeze 20 residential real estate assets owned by the Indian Government. The Award was passed by the Tribunal on 12 December 2020. The Award is not available in public domain but has been widely reported. The Tribunal held that India had failed to comply with its obligations under the India-UK BIT and directed payment of a compensation of $1.2 billion to Cairn. India has appealed against the Award in the Netherlands.
Meanwhile, Cairn has registered the Award for enforcement in several countries after identifying Indian assets worth approximately over $ 70 billion. The French Court's order was part of Cairn's efforts to enforce the arbitral award. The 20 residential properties which have been directed to be frozen are worth approximately $ 23 million. This is only a fraction of the $1.2 billion Award in favour of Cairn.
The Indian Government's decision to scrap 2012 Amendment
On 5 August 2021, the Centre proposed the implementation of the Taxation Laws (Amendment) Bill, 2021 ("Bill") to do away with the 2012 Amendment. The Bill stated that the 2012 Amendment invited criticism from stakeholders with respect to its retrospective nature. It was argued by critics that such retrospective amendments militate the principle of tax certainty. This severely affected India's reputation as an attractive destination for foreign investment. Under the Bill, any tax demand raised for indirect transfer of Indian assets made before 28 May 2012 would stand nullified. In order to be eligible of the benefits under the proposed law, the companies would have to withdraw all cases pending against the Indian Government and furnish an undertaking that no claim for damages, costs, or interest would be filed thereafter. The Bill received its final form as a law after receiving the assent of the Lok Sabha, Rajya Sabha, and the President of India on 13 August 2021.
Notably, the 2012 Amendment has resulted in three investment treaty arbitrations against India i.e., (i) Vodafone International Holdings BV v. India; (ii) Cairn v India; and (iii) Vedanta UK v. India. In our opinion, clearly this is not an isolated incident. A similar award was passed against India and in favour of Vodafone for $ 5.47 million as partial compensation in September 2020. The dichotomy here is the balance of a State's sovereign taxation power and its commitment under international law. Taxation disputes by multinational companies (especially widely reported and long drawn ones like Cairn) certainly have an adverse impact India's image as an investment destination. It was important to do away with the tarnished image of Indian tax regime at a juncture where post pandemic economic recovery was the need of the hour. Indian Government has the option to challenge the order of the French Court and/or pursue settlement and preserve Indian assets abroad. However, drawing out the dispute is not in favour of India's international image. With the new law in place, it is likely that the Indian Government is looking for a settlement. According to reports, Cairn is in talks with the Indian Government.
Cairn has carefully selected jurisdictions such as US, UK, Singapore, France etc. which Convention on the Settlement of Investment Disputes between States and Nationals of Other States 1965 ("ICSID Convention") to execute the arbitral award. Meanwhile, India is not a signatory to the ICSID Convention and does not have a reliable framework for enforcement investment treaty awards. Indian Arbitration framework is ill-equipped to deal with awards from investment treaty arbitration. It is unclear whether dispute between the private investor and the State would fall within the purview of the Arbitration and Conciliation Act, 1996. On one side, it has been held that the dispute between the private investor and the State is neither an international commercial arbitration nor a domestic arbitration2. This is because investment treaty arbitration arises from public international law, State obligations and administrative law. However, some High Courts have been of the view that the Arbitration and Conciliation Act, 1996 would apply to investment treaty arbitration.3
In the coming years, there is a need for the Supreme Court to clarify this position or for the legislature to a legal framework for enforcement investment treaty awards in India. The ambiguity and lack of proper framework for enforcement is contrary to India's goal of becoming an arbitration as well as investment hub. This is more so when coupled with the back-to-back adverse arbitral awards against India in investment arbitration. The evolution of a framework for enforcement of investment treaty arbitration in India has become more important than ever to save face internationally.
1. Vodafone International Holdings B.V v. Union of India, Civil Appeal No.733/2012.
2. Union of India v. Vodafone Group Plc, 2018 SCC Online Del 8842.
3. Board of Trustees of the Port of Kolkata v. Louis Dreyfus Armatures, 2014 SCC Online Cal 17695.
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