Cairn’s recent move to seize India’s state assets in order to enforce its arbitration award was viewed by many as an appropriate response to India’s intransigence. However, it is important to reflect on the many gray areas of law that need to be given due consideration.
After the world wars, as more and more countries gained sovereignty, they viewed foreign investment as more of a form of neo-colonialism. For many years, politics in developing countries has been turned inward. As a result, developed countries tried to protect their investments from expropriation. Bilateral investment agreements have become the most important tool for forging relationships between developed and developing countries. Some argue that the US in particular has signed BITs to pass standards for quick, adequate, and effective compensation in the event of expropriation. With the advent of globalization, BITs became a vehicle for foreign investment in developing countries. Although the impact of investment treaties on foreign investment is still highly contextualized and inconclusive, it has shaped international investment relations.
The BITs retained the old world construct that allowed international arbitration. However, many developing countries view tax arbitration as a violation of their sovereign tax law. The taxation of cross-border income is regulated either by domestic dispute settlement procedures or by competent authorities charged with agreeing on a non-binding result for the taxpayer. The option of arbitration if the Mutual Agreement Procedure (MAP) is unsuccessful is not available in India. Even when the OECD published its multilateral instrument for amending the tax treaty, India reserved the right to use binding arbitration. BITs thus avoid such restrictions and offer taxpayers the opportunity to represent themselves and to quickly enforce an arbitration award. Because of this, there has been an increasing trend in tax disputes with BITs over the years. The Cairn case is one such case that has been sought arbitration, especially since MAP was not an option. The UK-India tax treaty allowed capital gains to be taxed under Indian law. India has challenged the admissibility of the case in the arbitration tribunal. However, the case is based on a distinction between tax and tax-related investments. Certainly all investments have tax implications, and the acceptance of such a distinction could lead to problems even if taxes are explicitly worked out from the bilateral investment agreements.
In 2012, explanations were added to the Income Tax Act 1961 – these provisions were considered retroactive. This was more in response to the Supreme Court’s ruling in the Vodafone case, which opposed the Income Tax Department’s assertion of tax claims arising from the offshore transfer of interest, most of which derived its value from India. While retrospective changes are generally not ideal, they are not uncommon. In the UK, for example, such a change was introduced in 2008 to review the use of bypass rules across the Isle of Man. While it is possible to challenge the constitutional validity of such legislation, the legislature has the power to change tax law and the outcome of such challenges depends on the decision of the Court of Justice. In fact, a retrospective change may be acceptable if it intends to correct a legal loophole – provided it is not disproportionate. The explanations to the IT law of 2012 actually tried to remedy tax avoidance. The tax loss due to such a loophole is reportedly equivalent to the securities transaction taxes levied in a year, raising the question of whether the legislation has restored taxpayers’ equity.
When looking at the details of the Cairn case, it is hard to miss the series of reorganizations that tiptoeed around the tax laws of several jurisdictions resulting in tax non-payment. The gains from the sale of shares in Cairn India Limited are also evident. Taxing indirect offshore transfers – a structuring tool to obtain tax advantages from the indirect sale of assets – is not only possible in India (336 tax treaties contain such an article). It can also be seen that the underlying assets of the subsidiaries were immovable property in India. So is the International Court of Arbitration the most appropriate forum to deliberate on a matter related to tax planning?
Those questions are now before the Delhi High Court. What complicates matters, however, is that the retroactive taxation has been challenged due to the denial of fair and just treatment, similar to expropriation. But would the tribunal’s decision stand if it were determined that the predominant purpose of the transaction was indeed tax planning?
An end to the dispute seems unlikely. It raises many questions that administrators need to address through reforms. The conflict between the position of the tax department and the BITs to resolve disputes is usually the result of conflicting laws in different departments. The Indian BIT model introduced in 2016 provides a remedy here through the specific tax exclusion. Recognizing a tax investment dispute as distinct from a tax dispute should not undermine such an outsourcing. It is also important to note that even if the arbitral award is enforced, the issue of tax avoidance is pending in the High Court. Given the complexity, the only sensible solution would be a negotiated solution. Even if there is a solution in the Cairns case, legal issues remain.
This column appeared for the first time in the print edition on July 21, 2021 under the title “Violation of a sovereign right”. The author is an assistant professor, NIPFP