India faced yet another step-back due to its retrospective taxation policy, a three-member arbitration tribunal under the Permanent Court of Arbitration, The Hague, has directed India to pay UK-based energy giant Cairn $1.2 billion in damages, along with interest and legal costs.
Barely three months after Vodafone Plc won an international arbitration against India’s Rs 22,100 has crore retrospective tax demand, the country on Wednesday suffered another blow arising from the controversial 2012 amendment to its tax laws.
Cairn Energy plc is one of the leading Europe based oil and gas exploration company, listed in the London stock exchange. It has discovered and developed oil and natural gas reserves all over the world. Cairn holds a balanced portfolio of exploration, development and production assets, currently with interests in the following countries; the UK, Israel, Senegal, Côte d’Ivoire, Mexico and Suriname.
Cairn Energy was established in India in around 1999, headquartered in Gurugram. In early 1999, Cairn made the first Rajasthan discovery – Guda field, followed by Saraswati in 2001. Mangala was their biggest discovery in 2003, followed by Raageshwari, Bhagyam, Aishwariya, Kaameshwari and GR-F fields in Rajasthan. In 2003, Cairn acquired 100% of the exploration interest and took over as the operator of the block.
As we have read that cairn energy was doing a great job in the oil and gas exploration projects in India. In 2007, the parent company of cairn India and Cairn India holdings, cairn energy the UK decided to move some of its shares from one company to another to manage its internal assets. The income tax department of India monitored it carefully and reported that cairn India is gaining 1000s of crores as a loophole, by transferring its assets and thus, it has to pay capital gains tax on the same.
Cairn energy India filed a case in the income tax appellate tribunal (ITAT), the income tax department won the case and the tribunal slammed a total valuation of 24,000 crore rupees on Cairn India. The case met with the same fate in Delhi high court.
In 2011, Cairn India made a deal with the Vedanta group to sell the majority of its stakes (58%). However, a minority stake of around 10% along with some dividends was seized by Indian authorities to ensure that the company does not run off without paying its taxes.
The bone of contention: retrospective taxation
This whole problem could have been solved with the tribunals and other courts in the nation but in 2012, the government amended the tax code having a retrospective effect. This amendment stated that all the offshore deals will be taxable, along with the deals done in the past or retrospectively.
What is retrospective taxation?
As the name suggests, retrospective taxation allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.
Countries use this route to correct any anomalies in their taxation policies that have, in the past, allowed companies to take advantage of such loopholes. While governments often use a retrospective amendment to taxation laws to “clarify” existing laws, it ends up hurting companies that had knowingly or unknowingly interpreted the tax rules differently.
Apart from India, many countries including the US, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies, which had taken the benefit of loopholes in the previous law.
The then finance minister Pranab Mukharjee favoured the tax policy but the NDA government criticised it heavily and hope of it getting changed after 2014 arose. But then again, the government kept going with the flow and this flawed law continues to haunt the foreign investors as well as the domestic companies.
Cairn Energy Plc had already sold its India subsidiary, Cairn India, to Vedanta Ltd, retaining only a 5% stake. But after the tax demand and subsequent initiation of arbitration by the company in 2015, GoI seized the stake and sold it to realise the claim. It also seized dividends totalling Rs 1,140 crore due to Cairn and set off a `1,590-crore tax refund against the demand.
UK-India bilateral investment treaty
A bilateral investment treaty (BIT) is an agreement between two countries regarding the promotion and protection of investments made by investors from respective countries in each other’s territory. In addition to IIAs, there also exists an open-ended category of investment-related instruments (IRIs).
In 1994, India and UK had signed a BIT for promotion and protection of investment by companies of each country in the other’s jurisdiction.
Among the various agreements, the treaty had then stated that both countries would strive to “encourage and promote favourable conditions for investors” of the other country. The two countries would, under the BIT, ensure that companies present in each other’s jurisdictions would be “at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other”.
What did the Permanent Court of Arbitration at The Hague say?
Akin to the ruling in the Vodafone arbitration case, the PCA at The Hague has once again ruled that the Indian government’s retrospective demand was “in breach of the guarantee of fair and equitable treatment”. It has noted that Cairn UK’s argument that the demand on them was made after the Vodafone retrospective tax demand, which has since been set aside by Indian courts.
One of the major factors for the Court of Arbitration to rule in favour of Cairn energy was the violation of the BIT and the United Nations Commission on International Trade Law (UNCITRAL).
The permanent court of arbitration made a conclusion that the said shares come under the BIT and thus, these shares do not attract any of the domestic taxes applied in India. In its ruling, the court said that India has to pay the 10% stakes which were seized along with the damages that were suffered by the company which is valued around 1.2 billion dollars. The arbitration tribunal also said that now since it had been established that India had breached the terms of the agreement, it must now stop efforts to recover the said taxes from Cairn energy.
Indian government at this stage has two options, one is to continue the taxation policy and keep paying fines like these and get used to the backlashes coming from international market and investors or to change its present policy and gain the faith of possible investors. Indian government need to learn a lesson from these cases and has to stop surprising companies with absurd tax increases.
The tax policies need to be relaxed for the Indian market to flourish, both domestically and internationally.