International Tax Panorama

Barely 3 months had passed since Vodafone had won an arbitration case from India over the retrospective tax legislation amendment. In another setback, the Indian government has lost a similar international arbitration case to British energy giant Cairn Energy over the retrospective taxation, and has been asked to pay damages worth $1.2 billion to the UK firm.

Brief case summary:

The case goes back to the Rs 24,500-crore tax demand by Indian tax authorities on capital gains made by Cairn in the reorganisation of its India business in 2006-07. Like Vodafone, this dispute between Cairn and the Indian government also relates to retrospective taxation.

• In 2006-07, Cairn UK transferred shares of Cairn India Holdings to Cairn India, as a part of internal rearrangement.
• Cairn Energy got its first Income tax notice in January 2014 regarding information about the group reorganisation in 2006.The department also attached its near 10 per cent shareholding in its erstwhile subsidiary, Cairn India.
• Cairn Energy had in 2010-11 sold Cairn India to Vedanta. Following the merger of Cairn India and Vedanta in April 2017, the UK firm’s shareholding in Cairn India was replaced by a shareholding of about 5 per cent in Vedanta issued together with preference shares.
• In March 2015, the tax department sought Rs 10,247 crore in taxes on alleged capital gains made by Cairn in the internal reorganisation.
• In addition to attaching its shares in Vedanta, the tax department seized dividends totalling Rs 1,140 crore due to it from those shareholdings and set off a Rs 1,590-crore tax refund against the demand.
• Thus, in 2015, Cairn Energy initiated an international arbitration to challenge retrospective taxation.

The Ruling:

The Hague Permanent court of arbitration has ruled that India’s tax claim was invalid on the grounds that the retrospective tax demand breached the U.K.-India bilateral investment protection treaty. The three-member tribunal unanimously said that the retrospective demand was “in breach of the guarantee of fair and equitable treatment”.

As far as the issue of jurisdiction is concerned the tribunal said the Cairn case was also an investment-related dispute, not just a tax-related, which allowed the tribunal to hear over the case.

Implications of the ruling:

The ruling is being perceived as India’s dual loss in an international arbitration in relation to retrospective tax dispute with international investors. Retrospective legislation always directly affected the foreign investors’ right to certainty in tax matters while investing in India.

How Retrospective legislation is a direct violation of the taxpayers’ right to certainty?

A legislature may either introduce anti-avoidance rules with presumptions that will be later further fleshed out by the tax authorities, may change the rules retrospectively in order to tackle specific transactions, or may use anti-avoidance rules to justify expropriation for political reasons. In India, there was problematic application by the judiciary of transfer pricing rules in the Vodafone International Holdings B.V. case. The tax authorities tackled a holding company structure by applying a limitation on benefits provision through judicial interpretation in order to subject the taxpayer to withholding tax in India on the capital gains arising from an indirect transfer of shares. The Indian Supreme Court ruled in favour of the taxpayer on 20 January 2012, stating that this indirect transfer of shares was outside the tax jurisdiction of the Indian tax authorities and was thus not subject to any withholding tax in India.Despite this ruling, the Indian government introduced retrospective amendments to its tax law that would have resulted in the Vodafone transaction’s being subject to tax in India.

These was a watershed moment for foreign investors investing in India, as many became wary of the retrospective legislation. Implementation of Retrospective rules had an adverse impact on taxpayers right to certainty and also created an uneasy atmosphere of unpredictability that a State may use it as a last resort in order to overturn its own Supreme Court decision.

Looking forward: Will Indian goverment appeal ?

The ruling has definitely come as a relief to the foreign investors, who were wary of investing in India as a result of retrospective tax changes. The verdict is definitely a blow for the aggressive position taken by tax department. The victory may finally signal an end to the constant retrospective tax changes made under the legislation that had damaged the reputation of the country for being aggressive.

However, on the same day of verdict, the Indian government challenged against the international arbitration court’s verdict in Vodafone at Singapore.

The Indian government has appealed on the ground that the tax matters is not covered under investment protection treaties and the law on taxation is a sovereign right of the country. Thus the internaional tribunals’ rulings cannot override the sovereign powers of the legislature in framing tax policies. However, such appeals can still create an aggressive image of the Indian tax authorities in reinforcing their retrospective taxes on the investors. Only the final result of this appeal will help to give a clear picture to the investors who are wary of investing in India.