Losing Much More Than An Award: Cairn Energy- India Dispute

This is authored by Sanaya Khadiwala of ILS Law College, Pune.

Introduction:

The infamous Cairn Energy case has held the limelight not only in India but throughout the world in the area of Investment Arbitration. This case, in a nutshell, is between the Government of India and Cairn Energy regarding the much-debated retrospective taxation issue. The present article tries to analyze this case by raising two issues, firstly, whether these international treaties and international arbitration limits a sovereign’s right to domestic laws (taxation rights) and secondly, the impact of this case on India’s FDI encouragement strategy.

The Dispute:

Cairn UK Holding Ltd. (“CUHL”), a UK based company, was the parent company of the wholly owned subsidiary Cairn India Holding Ltd. (“CIHL”) – a US based company. In a 2006 transaction, CUHL transferred all the shares of its 9 other subsidiaries based out of India to CIHL. After this, in August 2006, Cairn India Limited (“CIL”) was incorporated in India as another wholly owned subsidiary of CUHL. This was followed by an, an internal group restructuring, CUHL transferred the shares of CIHL to the India based CIL, thus seeking indirect control over the 9 subsidiaries. Subsequently, in December 2006, CIL came out with an IPO in India of approximately 30 percent of its shares. This raised around INR 6101 crores and was received by CUHL through IPO collection and divestment of shares in their subsidiaries.

Later, in 2011, Vedanta Resources Plc. (“VUK”) became a stake holder of around 60 percent in CIL. CIL was later merged with Vedanta Ltd, a wholly owned subsidiary of VUK., under certain terms and conditions.

The Indian Income Tax Department (ITD) launched a retrospective tax investigation on the transactions undertaken prior to the IPO. Consequently, it levied tax on the 2006 transaction stating that the transfer of shares constitutes as ‘transfer of capital assets’ and demanded capital gain tax from CUHL. CUHL made an appeal to the Income Tax Tribunal, Delhi who upheld the ITD’s demand of the capital gain tax in 2017. However, Cairn Energy had already initiated international arbitration in accordance with the India-UK Bilateral Investment Treaty (BIT) in 2015 at the Permanent Court of Arbitration (“PCA”), The Hague. During the period of the arbitration, ITD had seized and sold some of CUHL’s shares along with their assets in India.

Recently, on 21st December 2020, the international arbitral tribunal gave out the arbitral award stating that the Indian Government has failed to uphold its obligation under the UK-India BIT by not providing ‘a fair and equitable’ treatment to Cairn Energy which is required under Article 3(2) of the treaty. As a result, the tribunal has ordered the Indian Government to cease its demand of capital gain tax and return the value of shares it had sold, dividends seized and tax refunds withheld to recover the tax demand.

Domestic Laws and their relations with International Treaties:

Bilateral Investment Treaties (“BIT”) have facilitated the growth of international investments at a remarkable rate. BITs offers encouragement to many foreign investors to invest in the host countries as they give assurance and protection to the them from certain changes in the host country’s laws. In case the host country violates any terms of the BIT, the investor has the right to initiate arbitral proceedings against the country in front of an international independent tribunal. Thus, BITs have proven to be an excellent tool of assurance to various foreign private investors for the security of their investments, especially in developing countries like India.

However, in the recent times, India has faced some criticism on protecting the investors interest. . In the present case of Cairn tax dispute, India’s main argument is on the grounds that under the UK-India Tax Treaty, capital gains are to be taxed in accordance with the domestic laws of each country as per Article 14 therein. In the case of Vodafone International Holdings BV v. Union of India(“Vodafone Case”), the Supreme Court of India discharged Vodafone of the tax liability imposed by the ITD and held that the sale of share in question to Vodafone did not amount to transfer of a capital asset within the meaning of Section 2(14) of the Income Tax Act. Following this judgement, the Indian Parliament passed the 2012 Tax Amendments which included the transfer of shares in the term “transfer”.

Thus, a big part of exercising the powers of the sovereign include the power to tax foreign investors. However, if an independent arbitration tribunal were to impose a limit or restriction on such a power, the sovereign’s authority might be threatened/challenged. While giving the arbitral award, UK-India’s BIT has been taken into consideration by the tribunal However, India’s Income Tax Tribunal had already given a judgment favoring India’s demand for capital gain tax which is in direct contradiction to the award given by the arbitral tribunal. This is a point of direct incongruity between the two rulings.

India has always believed in the duality of international laws which means that the principles of international law apply not as such, but as part of the municipal law.[i] Thus, the invocation of arbitration in such cases raise concern over the difference of private law questions and public law questions covered by these BITs. The right to collect and assess tax is at the foundation of the sovereign’s legal authority and structure. To put the power to preside over a government’s right to tax in the hands of an independent arbitral tribunal raises a few questions on India’s approach towards investment arbitration and public policy.

Cairn Energy Case and its Impact on India’s FDI:

In light of the Covid-19 pandemic, most of the investors were looking to pull out of China, the manufacturing hub, and were looking at alternative manufacturing destinations. India couldn’t have asked for a better opportunity in attracting big foreign investors, now that it has jumped over 73 places, scoring a 63rd rank in the ease of doing business. One of the most impactful aspect of FDIs include the various BITs that India has with different countries. This offers the investors the right to initiate arbitration which helps to encourage and build confidence in the mind of the investors towards India. However, India’s infringement of BITs in cases like Vodafone and Cairn Energy, both the awards coming in the midst of the Covid-19 pandemic, has been sending a contradicting message to private individual investors.

In the case of Cairn Energy, the arbitral tribunal ruled against India stating that India’s claim of the retrospective tax is ‘in breach of the fair and equitable treatment’ promised to the investors in the India-UK bilateral investment treaty. Even after the award was given, Cairn energy has moved to attach the assets of ‘Air India’ as according to them, Air India is the “alter ego” of India, and that it should be held jointly and severally responsible for India’s debts, including those arising from a judgment. This move could also be a consequence of the fact that India has not yet made any concrete statements on honoring the award and has rather filed an appeal challenging the same.

Looking at this case from the lens of foreign investment and lack of enforcement of Arbitral Awards, it does not put India in a positive light. Because of the recent cases of Vodafone, Cairn Energy, Vedanta etc., it could put the strategy of bettering investor relations in danger. Thus, instead of being the boost it hoped it would be, the consequence of these cases has led India two steps back.

Conclusion:

The Cairn Energy Case is not only about India’s demand for tax, rather it touches on many other areas which could potentially decide the future of India’s investment arbitration policies. If India agrees with the award in the future, this could bring about various changes in India’s approach towards international investment treaties and if India wins the appeals against Cairn, it has the potential to change India’s image as an investor-friendly country.

Both the cases of Vodafone and Cairn Energy boil down to challenging the reach of international treaties under domestic law. The Supreme Court, in the Vodafone case, gave a ruling favoring Vodafone which is in line with the PCA award in the Cairn Case. So, if India is hoping to recover from this tarnished image, India’s legislation should also come at par with the Supreme Court and PCA, in a unanimous view. Thus, the final decision of these cases will have a huge impact on India’s long-term investment policy and investment arbitration.

[i] T.Rajkumar v. Union Of India, [2016] 68 taxmann.com 182 (Madras).