By Bijal Ajinkya, Ashish Mehta, & Krutika Chitre, Khaitan & Co, Mumbai
Telecom giant Vodafone has won a contentious tax dispute with the Republic of India in international arbitration, invoking India’s investment protection treaty with the Netherlands, in a decision announced September 25.
The precursor to this award of the Permanent Court of Arbitration at the Hague was the Indian government’s decision to enact a retrospective ‘clarificatory’ amendment to the income tax laws, which overturned a Supreme Court decision in Vodafone’s favour.
The big question now is whether the Indian government will seek to overturn the international arbitration award.
The Vodafone saga
The Vodafone saga began in 2007 with the acquisition by Vodafone International Holdings BV, a company resident in the Netherlands, of shares of CGP Investments (Holdings) Limited, an entity resident in the Cayman Islands. Vodafone purchased the shares from another Cayman Islands company, Hutchison Telecommunications International Limited.
CGP, through its subsidiaries, held a majority stake in an Indian company, Hutchison Essar Limited (later Vodafone Essar Limited), resulting in a change in the ultimate shareholding of Hutchison Essar Limited.
The Indian tax authorities, in an unprecedented move, contended that capital gains arising from the transfer of CGP’s shareholding by Hutchison Telecommunications International Limited to Vodafone amounted to the transfer of a capital asset situated in India.
Notices were accordingly issued to Vodafone and Hutchison Essar Limited for failure to withhold taxes at source and in the capacity of a ‘representative assessee,’ respectively. The Indian government then initiated proceedings to recover taxes to the tune of approximately USD 2 billion.
Aggrieved, Vodafone filed a writ petition in the Bombay High Court. In its 2010 decision, the High Court held that the consideration payable for transfer of property such as telecom licenses, non-compete rights, and use of the brand name was a transfer of Indian assets taxable in India.
However, in an appeal by Vodafone, the Supreme Court reversed the Bombay High Court decision. The Supreme Court, in its 2012 decision, held that no part of the consideration paid by Vodafone to Hutchison was liable to tax in India.
The conclusion of this long-fought litigation, coupled with the much-needed clarity and certainty provided by the Supreme Court, was, however, short-lived and swiftly undone by India’s Finance Act of 2012.
Through the Finance Act of 2012, a retrospective ‘explanation’ was added to Section 9 of the Income-tax Act, 1961, which brought indirect transfers of Indian assets, i.e., the transfer of shares of an offshore company deriving substantial value from Indian assets, within the Indian tax net.
Through the Finance Act of 2012, a retrospective ‘explanation’ was added to Section 9 of the Income-tax Act, 1961, which brought indirect transfers of Indian assets, i.e., the transfer of shares of an offshore company deriving substantial value from Indian assets, within the Indian tax net.
Accordingly, transactions like Vodafone’s acquisition of CGP fell squarely within the taxable contours of the Indian tax law retrospectively from April 1, 1962.
Aggrieved by India’s move, Vodafone initiated arbitration India’s investment protection treaty with the Netherlands, which has now been decided in its favour.
Tribunal decision
From publicly available information, it appears that the arbitral tribunal unanimously held India to be in breach Article 4 (1) of the investment treaty, which states that investors of each country must be accorded fair and equitable treatment and enjoy full protection and security in the territory of the other party, at all times.
India’s conduct in imposing the tax liability retrospectively on Vodafone, along with interest thereon and penalties, notwithstanding the 2012 Supreme Court decision, was held to have fallen foul of its obligation under Article 4(1) of the treaty.
As per the extracts of the award (the full text is not in the public domain), India is required to “cease the conduct in question,” and any failure to comply with such obligation would “engage its international responsibility”.
Interestingly, arbitrations under India’s investment protection treaties are specifically covered in India’s recently enacted tax dispute resolution scheme, the Vivad se Vishwas Act, 2020.
The act gives taxpayers the option to settle their income tax disputes and get a complete waiver of interest, penalty, and potential prosecution by paying only the disputed tax within the prescribed time.
While there was no official confirmation on this front, this inclusion is popularly believed to have been inserted in the act to entice Vodafone and Cairn to settle their issues amicably.
India’s dilemma
News of the Vodafone award resulted in a prompt statement from India’s Ministry of Finance, acknowledging that the award and disclosing that a decision on a further course of action “including legal remedies before appropriate fora” would be taken.
One such remedy might be contesting this award before the High Court of Singapore, another option available with the Indian government is to contest the arbitration award’s enforcement in India when Vodafone approaches an Indian Court with such a request.
It will be interesting to watch the Indian government as it balances its international obligations with its legal remedies, given the interplay between international and domestic laws and the investor sentiments at stake.
It will be interesting to watch the Indian government as it balances its international obligations with its legal remedies, given the interplay between international and domestic laws and the investor sentiments at stake.
India’s current ruling party has condemned the introduction of retrospective laws (introduced by the former government) and has assured that they will not introduce any retrospective amendments in tax laws.
The Indian government will need to balance its goal of wooing global businesses to shift their manufacturing facilities in India and invest in India versus giving up potential revenue from pursuing the proceedings.
There are many more intangible factors at work here that cannot be ignored, the most important being global investors’ sentiments, which had taken a big hit when the retrospective amendment was introduced. — —
— Bijal Ajinkya is a Partner at Khaitan & Co, Mumbai.
— Ashish Mehta is a Partner at Khaitan & Co, Mumbai.
— Krutika Chitre is a Senior Associate at Khaitan & Co, Mumbai.
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