In recent times, multinational companies have taken increasing recourse to international arbitration under Bilateral Investment Promotion and Protection Agreement (BIPA) to resolve the income tax (IT) department claim on them arising from application of the 2012 retrospective legislation.
Spate of international arbitration
Thus, the British telecom major Vodafone had invoked the India-Netherlands BIPA seeking international arbitration in its long-drawn Rs 20,000 crores tax dispute with the tax department following cancellation of its conciliation talks with the Government of India (GOI). Similarly, the Finnish mobile handset maker Nokia resorted to the treaty to resolve the tax department claim of over Rs 21,000 crores tax liability, both in the form of existing and anticipated liability, for seven years commencing 2006-07.
More recently, Cairn Energy Plc (CEP) – the British oil exploration and production company – has sought compensation from India for steep fall in the value of its 10% stake in Vedanta controlled Cairn India Limited (CIL) under the ambit of India-UK BIPA. In January 2014, the I-T department had provisionally attached its ‘residual’ shareholding in CIL then valued at about US$ 1 billion until CEP settled the retrospective tax demand of Rs 10,200 crores relating to creation of Indian subsidiary in 2006.
CEP has justified its action on the ground that India’s actions breached several of its obligations under the UK-India Investment Treaty, including its obligation to “create favourable conditions” and ensure “fair and equitable treatment” and “full protection and security for Cairn’s investments. Others have also used similar arguments to buttress their respective claims for compensation.
Bilateral Investment Promotion & Protection Agreement (BIPA)
When, a foreign company brings in money to India, it has a legitimate expectation that its investments will be fully protected and their safety will be fully assured. Therefore, it demands an assurance from the host government in fulfilment of this expectation. Signing agreement with individual companies to reflect such commitment will be a cumbersome and unwieldy affair as hundreds of thousands of companies are involved.
Apart from being impractical, no sovereign government will ever venture in to this as it could run the risk of being burdened with unlimited financial liabilities as any entity would raise demand for compensation at the drop of a hat. It will also amount to blatant transgression of domestic laws and regulations and seriously undermine the authority of the government.
A practical approach is for GOI to enter in to bilateral agreements with governments of foreign countries which encapsulate necessary assurances for investor/companies which operate from those jurisdictions. A company facing threat to its assets/properties may seek redress under the ambit of agreement with the country where it is headquartered. India has BIPAs with 83 countries.
The agreements provide for compensation for expropriation, which means compensation for direct taking away of properties or for regulatory or taxation measures which deprive investor of substantial benefits arising from investment. Indo-Mauritius BIPA recognizes ability of shareholders of a company whose assets have been expropriated to initiate action to claim compensation for his share value. The most-favoured nation (MFN) clause makes a provision for applying Mauritius treaty to any other treaty.
BIPAs make India potentially vulnerable
The canvass of obligations under treaties is pretty wide. The phrases like “unfair” and “unfavourable’ treatment can be subject to multiple interpretations. And, scope for such interpretations is even greater when such cases are subject matter of international solicitation as provided for under BIPAs. All this has the potential to subject Indian government to huge vulnerabilities and may even result in depriving it of its legitimate dues as per its extant laws.
One can understand a foreign investor’s right to claim compensation for outright expropriation of its assets/property though unlike in authoritarian regimes where expropriation is order of the day, India being a mature democracy, such drastic action is unlikely. Yet, safeguards may have to be provided to guard against even most unlikely event. After all, we had nationalization of banks and coal mines in late 60s & 70s setting precedent!
But, to go beyond this and incorporate stuff like “regulatory or taxation measures which deprive investor of substantial benefits arising from investment” is fraught with serious consequences. This is much too wide and ambiguous and could be amenable to misuse. What makes matters worse is application of MFN – a concept evolved in the context of WTO rules on fair and non-discriminatory trade in a multilateral context – to BIPAs which are country specific. Any attempt to transpose provisions of one treaty to another, implied in MFN, could be fraught with huge risk?
Vodafone case & 2012 amendment to I-T Act
Most of the cases where the affected company is dragging GOI to international arbitration involve levy of tax on capital gains made by a subsidiary of an MNC headquartered in a foreign country on sale of its equity shares to another company also located in a foreign jurisdiction. The I-T department was collecting a tax on the gains made from the transaction as per Indian law and following due processes as laid down under the Act and rules thereon. The demand was challenged in the court.
In 2012, in Vodafone case, the Supreme Court held such levy untenable as per the prevailing law when sale/purchase of shareholding happened in 2007. Considering its far reaching ramifications and revenue implications running in tens of thousands crores for similar transactions of a host of other companies, Indian parliament passed an amendment to I-T Act and made it applicable with retrospective effect.
The said amendment of 2012 was essentially in the nature of a ‘clarification’ and intended to plug a gaping loophole in the subsisting law that enabled foreign companies get away with billions of dollars profit and yet not pay any tax to host government (read GOI) where that asset is located. The investors are objecting to such retroactive demand for tax and decided to contest in international arbitration as the government refused to grant exemption.
Do the above actions of Indian government amount to depriving investor a substantial benefit? Do these tantamount to expropriation of foreign investor’s asset/property? Have the investors been treated in an “unfair” and “unfavourable” manner? Is there any breach of obligations under the treaty?
The answer to above questions is a categorical “NO”! Far from expropriating assets or denying substantial benefit, all that the department is doing is to take away only a portion of substantial gain the foreign company made on sale of its shares to another company. If, former makes US$ 100 from transaction, then after paying tax @ 30% it would still be having net gain of US$ 70. Clearly, the government is making no encroachment whatsoever on assets or benefits from investment by foreign company.
As regards, whether tax can be levied retrospective or otherwise, the investor – foreign or domestic – has absolutely no locus standi to sit in judgement over the government. The taxes are levied as per the law of land and the parliament has the supreme authority to make the laws. Even so, shorn of rhetoric/media hype over this retroactive amendment of 2012, it would be unfair to surmise that this was meant to create an un-favourable environment or hand out a hostile treatment to foreign companies.
India’s jurisdiction to tax capital gain on share transfer
Piloted by the then finance minister Pranab Mukherjee and now President of India, it was intended to plug a loophole in the extant law due to which government was loosing huge revenue. What was that loophole? If, a share sale/purchase deal takes place between two companies incorporated in foreign countries, the loophole ensured that India had no jurisdiction to collect tax on gains made/income generated from such transactions. This was preposterous!
How could GOI be denied the right to levy tax on income/capital gains generated from a deal that involves an asset residing within Indian territory? This underlying fundamental cannot be brushed aside simply because the owner of this asset and its purchaser are sitting in a foreign land. In a globally interdependent world where a major chunk of ownership of assets located in India vests with MNCs, such an approach will only mean progressive loss of revenue that in all fairness belongs to this country.
So, Pranab Mukherjee decided to remove this glaring anomaly which unfortunately was given a different twist thanks to the inherently derogatory connotation appended to the word ‘retrospective’. The Modi – dispensation is well aware of the positive aspects of 2012 amendment and that is why in the over-arching national interest, for now, it has refrained from taking any action to reverse it despite unprecedented pressure being brought to bear on it.
Modi – government should catch the bull by horn
Nor, is the government showing any undue anxiety to stop forth with the notices and demands that are already on plate; it is allowing tax department to take its own course as per law of the land and procedures. However, to soothe the ruffled feathers of MNCs, it has refrained from raising fresh retroactive demands. But, this hand holding cannot be allowed to continue for long. Modi should catch the bull by the horn sooner than later.
The government should come out of the shell and explain to investors as to how can the very country (read India) which enables them make profit from underlying assets located here be deprived of its legitimate tax dues? If, earlier they were getting away without paying any tax exploiting a loophole in our law then, it does not confer on them a permanent right to continue with the same practice. They must be told so in no ambiguous terms.
It should also be clarified that correcting a past wrong cannot be equated with expropriation of their assets. Invoking BIPAs to claim compensation for alleged loss (which simply does not exist) is uncalled for. Things are simply going bizarre when CEP even wants offset for erosion in value of shares which it attributes solely to attachment albeit ‘provisional’ of its 10% residual holding in CIL by I-T department! Emboldened by such actions, in future, companies would seek compensation for any business loss linking the same to executive action in one way or the other.
Tax policy – strike balance between investor interest & revenue
While, stability and predictability of taxation and policy environment is an absolute must to attract foreign investment, this cannot be at the cost of making an abject surrender and forgoing huge revenue that legitimately belongs to India. MNCs should not be allowed to take India for a ride merely in the name of seeking stability of the policy environment. The tax policy should strike a judicious balance between protecting interest of foreign investor with those of optimizing revenue to meet development needs.
The world over, national governments are concerned at the actions of MNCs in denying to them their fair share of taxes and already a lot of institutionalized action is in progress under the aegis of OECD (Organization for Economic Cooperation and Development) – an umbrella body of developed countries – to remedy the situation. Indian action to protect its revenue interest must not be viewed differently. The government should engage proactively with OECD to get requisite support for its stance vis-a-vis MNCs.
Such an engagement must also clearly expose the hollowness of MNCs allegations that government actions have in any way, deprived them of the benefit from their investment. The reality is that the former had already made substantial gains and the money repatriated. All that the latter is endeavouring to do is to garner a portion thereof being its legitimate tax dues.
Instead of going for international arbitration invoking BIPA which is totally un-warranted, the concerned companies should sit with the government and arrive at a settlement fair to both. A preferred arrangement could be one where the companies agree to pay the tax as per existing law – post-2012 amendment – sans interest and penalty. Modi should use his diplomatic skills and statesmanship to hammer such settlements which will be a win-win for all stakeholders.