In a span of just three months, Modi – government has been confronted with two orders of an international arbitration tribunal overturning demand raised by the Income – Tax (IT) department on multinational companies in back taxes on income arising from capital gains by made by the latter on sale of their ownership in Indian companies – running into tens of thousand crore.
First, on September 25, 2020, an international arbitration tribunal rejected Indian tax authorities’ demand for Rs 22,100 crore in back taxes (Rs 7,990 crore plus interest and penalty) relating to Vodafone Group Plc (the British telecom giant) US$ 11billion acquisition of 67% stake in the Hutchison Essar Ltd (HEL) – an Indian company running mobile phone business – owned by Hutchison Whampoa (HW) in February 2007. The acquisition was made through former’s Netherland based subsidiary Vodafone International Holding buying 100% shares of Cayman Island-based subsidiary of the latter viz. CGP Investments that in turn, held 67% share in HEL.
The tribunal held that the Indian Government demand from Vodafone using retrospective legislation was in “breach of the guarantee of fair and equitable treatment” guaranteed under the bilateral investment protection pact between India and the Netherlands. It also asked the government to reimburse Vodafone 60% of its legal costs (about Rs 85 crore) and half of the 6,000-euros cost borne by Vodafone for appointing an arbitrator on the panel.
Second, on December 23, 2020, a three-member tribunal at the Permanent Court of Arbitration in The Hague invalidated India’s March 2015 tax claim of around Rs 24,000 crore (Rs 10,247 crore in tax plus interest and penalty) on British energy behemoth Cairn Energy on capital gains made by it on the ‘internal reorganization of its India business’ run by Cairn India in 2006-07 (then Cairn UK transferred shares of its subsidiary Cairn India Holdings to Cairn India).
As for Vodafone, in this case also, the tribunal ruled that the retrospective demand was “in breach of the guarantee of fair and equitable treatment” guaranteed under the UK-India Bilateral Investment Treaty”. It also ordered the Indian IT department to return up to US$1.2 billion to Cairn Energy in funds withheld by the former including (i) the value of latter’s 10% shares in Cairn India attached and sold (during 2011, even as Cairn Energy had sold majority of its holding in Cairn India, to Vedanta, the department did not allow it to sell 10%); (ii) seizure of dividends that the company paid to its parent and (iii) tax refunds withheld to recover the tax demand. Add US$ 200 million of interest and US$20 million of arbitration cost, the total comes to US$1.4 billion.
Reportedly, Cairn can use the arbitration award to approach courts in countries such as UK to seize any property owned by India overseas to recover the money, if the award is not honored.
There is massive uproar among the investors and the media over the decision of Modi – government to raise these demands in the first place and thereafter pursue in the court. They argue that raising the demand using a retrospective amendment in tax laws (this was enacted in 2012 by the then UPA – government to negate a judgement of the Supreme Court in Vodafone case that had declared untenable tax demand earlier raised by on the February 2007 transaction; armed with this amendment, the IT resurrected that demand besides raising demand on Cairn Energy using the same law) affects long-term stability of the fiscal environment and undermines investor confidence.
Prima facie, retrospective amendment in tax laws may look bad. The investor can argue that he takes decision on the basis of prevailing law of the land and if that law is changed midstream, this is unfair as it undermines the very basis of his business decision. The million dollar question is: did the then government fundamentally alter the law? To get to the bottom of the truth, we need to closely look at the genesis behind the 2019 amendment.
The cardinal principle of taxation is that tax is levied on income generated from an asset. In the Vodafone case, the underlying asset was mobile phone business then run by an Indian company Hutchison Essar Ltd (HEL). Hutchison Whampoa (HW) having 67% shareholding in HEL through its fully owned Cayman Island-based subsidiary viz. CGP Investments sold the entire 67% to Vodafone’s Netherland based subsidiary Vodafone International Holding. From sale of these shares, HW made capital gain equal to the excess of sale price over the cost of their acquisition.
The gain was made possible due to increase in valuation of the Indian asset viz. HEL – rechristened Vodafone India Limited (VIL) after acquisition of majority shares by Vodafone – hence, GOI is fully entitled to collect tax on this income. Yet, the firms exploited an ambiguity in the extant law by giving effect to the transaction through 100% subsidiary of the seller (CGP Investments) and the purchaser (Vodafone International Holding Ltd) incorporated in different jurisdictions viz. Cayman Island and Netherland – thus, making it look like an ‘indirect transfer’ of Indian assets.
To stop abuse and plug the loophole of such indirect transfer of Indian assets, in 2012, the Government amended the law to make such transfers (albeit indirect) taxable in India. The amendment was merely in the nature of a ‘clarification’ to the subsisting law aimed at making the intention of the law explicit. The real intent was to ensure that on the income generated from an ‘underlying asset’ in India irrespective of how this transaction was given effect – direct or indirect transfer of shares – is taxed by Indian Government.
True, this was done after the transactions had happened. While, this may give it the color of being retrospective, the fact remains that the amendment was only in the nature of a ‘clarification’; that it can’t be construed as a change in the law itself. Assuming – for the sake of argument – that GOI can’t collect tax (on the basis that any retrospective change even by way of a clarification is not permissible), then, are we to infer that the capital gains made by seller of the Indian asset namely Hutchison Whampoa (HW) will go untaxed. Does it not violate the basics of taxation?
The demand (read fresh) raised by the IT department is pursuant to a law passed by a sovereign Parliament (read: 2012 amendment). There is absolutely nothing illegal about it (had it been so, the top court would have declared it invalid).
The ruling of international arbitration tribunal cites the tax demand as being violation of India’s obligation under Bilateral Investment Treaty with concerned countries. The argument does not hold water as what Indian government has done is ‘only to levy tax on the earnings of the companies’; there is nothing to suggest that latter’s investment in India has been put at risk. Even so, taxation is not covered under investment protection treaties and the law on taxation is a sovereign right of the country.
In Cairns Energy case, the tribunal has referred to a statement by the then Finance Minister, Arun Jaitely on November 7, 2014 that his government had taken a “policy decision that as far as this government is concerned, even though there is a sovereign power of retrospective taxation, we are not going to exercise that power”. The demand raised by IT department is in no way incongruous with Jaitely assertion as it is merely the result of removing an ambiguity in the extant law and certainly does not fall in the category of retrospective tax.
Meanwhile, Jaitely had also observed that “as regards cases, where retrospective demands had already been raised and matter is pending in court, the judicial process will be allowed to run its course”. The order of the arbitration panel is not the end of judicial process. Therefore, any action of the government in challenging this ruling won’t be in contradiction with Jaitely’s views.
To conclude, India’s sovereign taxation rights can’t be held hostage to its bilateral investment treaties with other countries. Keeping this overarching consideration in mind and opinion of the Solicitor General that an “arbitral tribunal can’t render a law passed by a sovereign Parliament ineffective,” the Government has decided to challenge the tribunal order. In Vodafone case, on December 24, 2020, it filed a petition in the Singapore court well within the 3 months deadline from the date of order. In the Cairn Energy case also, it will challenge tribunal’s order within the deadline.
Undoubtedly, India needs foreign investment in its march towards accelerated growth. But, this can’t be taken to mean that the government will forgo its legitimate tax dues on the gains made by foreign investors from their operation here. It should pursue all available legal options to make the concerned companies pay up.