Mehak Jain & Arush Mittal[i]
The decision of the Permanent Court of Arbitration (‘PCA’) at the Hague, marks the apotheosis of a decade long bitter tax dispute between the Vodafone Group Plc (‘Vodafone’) and India. The PCA unanimously ruled in favour of Vodafone and held that the exhortation of a retrospective tax on Vodafone violated the fair and equitable treatment (‘FET’) provision of the bilateral investment treaty (‘BIT’) between Netherlands and India (‘India-Netherlands BIT’). The judgement of the PCA has not been made public (yet) and hence the subsequent measures to be taken by the Indian Government remain uncertain. The purpose of this post is to view the ruling from an impartial lens, discuss the validity of a retrospective amendment of tax law in India, and analyze the violation of the FET clause in the India-Netherlands BIT. This post also examines the impact that the PCA ruling would hold at a global level.
The Decade-old Saga
The 10-year long tax battle began with an agreement between Vodafone International Holdings (‘VIH’), which is a Dutch subsidiary of the UK-based Vodafone group and Hutchison Telecommunications International Limited (‘HTIL’). Per this agreement, VIH acquired a Cayman Islands based company, CGP Investments (Holdings) Ltd. (‘CGP’), which was a subsidiary of HTIL. Notably, CGP held a 67% stake in Hutchison Essar Ltd., which was one of the leading players in the Indian telecom industry.
The Indian Income Tax department imposed a capital gains tax on this transaction and initiated proceedings against Vodafone when it refused to comply. Vodafone approached the Bombay High Court, which ruled in the favour of the Tax department; however, this verdict was later set aside by the Supreme Court of India in 2012, which ruled in favour of Vodafone on the grounds that the transaction was concerned with a share sale, and not an asset sale.
Soon after this judgment, in 2012 itself, the Income Tax Act was retrospectively amended and explanations were added to the relevant Sections to provide that income arising from sale of shares or units shall be deemed to arise in India if the transaction had taken place outside India, and its value depended primarily on assets in India. This effectively overruled the Supreme Court’s verdict and Vodafone resorted to international arbitration seeking remedy, alleging that the FET clause assured under the India-Netherland BIT was violated.
Validity of a Retrospective Tax Law
A retrospective tax law amendment is imposed to rectify the defect (by making ‘small repairs’) in the phraseology; an infirmity or a lacuna of any nature so the Government can realize the tax through an amending and validating act. The concept of retrospective taxation has been well-established and accepted as being valid and the same is followed globally by established economies such as Australia, Netherlands, US, UK, Canada, Italy and Belgium. The Supreme Court of India in the case of Rai Ramkrishna v. State of Bihar was emphatic about the competence of the legislature to enact and implement taxation laws with retrospective effect. This decision was reiterated by the Court in the case of Jawaharlal v. State of Rajasthan; where the powers of the legislature was observed to make amendment in tax laws with prospective as well as retrospective effect. The landmark judgement of Indian Aluminium Co. v. State of Kerala declared that the legislature, within its legislative field, can enact a valid law and render a judicial decision futile by altering its character retrospectively.
Delving into the matter at hand, Vodafone was efficacious in finding a loophole in the Indian legislation to transfer Indian assets by dodging tax imposition with the help of foreign companies; exploiting the void in the Indian tax laws and making it appear as creative tax planning. The verdict of the Supreme Court in 2012 blurred the distinction between tax evasion and tax avoidance as it could not be established whether Vodafone used the corporate structures with the primary aim of avoiding the specific tax at hand. The Indian Government urged the Court to lift the corporate veil and see the true nature of the Vodafone transaction. Non-compliance of the same left the government with no choice but to fill the void in tax laws by enacting a retrospective amendment, and in turn, gave itself the power to re-open past transactions where the underlying assets were based in India and impose tax on offshore indirect transfers (‘OIT’).
The transaction of Vodafone is strikingly similar to the indirect sale of Petrotech Peruana (Peruvian oil company) and the indirect sale of various assets by Zain in Africa and Uganda. In most of the cases, the country in which the underlying assets were located, lost in court. India and Peru lost due to the insufficiency of domestic taxation law, and Uganda lost due to a potential override of a treaty. Peru and Chile amended their taxation laws with retrospective effect to bring in OITs, similar to India’s retrospective tax law of 2012. The 2011 version of the UN Treaty, and the 2017 update of the Organisation for Economic Co-operation and Development Model Tax Convention (‘OECD MTC’), under article 13(4), provides for the taxation of OITs. Not forgetting the impartial stance, it is also important to look at the breach of the FET provision by India.
FET Clause violation
The arbitral award found the Indian Tax department guilty of Article 4(1) of the India-Netherlands BIT, i.e. the standard of Fair and Equitable treatment. The FET standard, as interpreted and defined in multiple cases such as CMS v. Argentina and PSEG v. Turkey has been said to include an implicit guarantee of predictability and stability in the legal framework of the host country to safeguard the interests of the investors.
Now, it might be argued that retrospective amendments are valid in tax laws that is the position in multiple jurisdictions, and an FET clause cannot be invoked merely because a country amended its legal framework. A decision delivered during Argentia’s economic crisis is of relevance here. In Salini Impreglio v. Argentina, the Tribunal while relying on Parkerings-Compagniet AS v. Lithuania adjudged that while the legal framework of a country is susceptible to change and an investor will be unreasonable not to expect so, the Tribunal also observed that an investor ought to be protected from any unreasonable modifications to the law. In this case, the modification of the law was unreasonable in the sense that after the highest court of the country gave its ruling, the amendment made was worded in a manner that it rendered the ruling ineffective. The conduct of the Indian government in enacting a retrospective amendment and circumventing the Supreme Court’s verdict indicated an atmosphere of instability and uncertainty in India for foreign investors, where exhausting the available remedies and getting a favourable verdict in the country’s apex court would still not guarantee relief to the investors.
Concluding remarks
While the detailed reasoning behind the tribunal’s award has not been public yet, it is important to deliberate upon two points: firstly, the impact this award shall have on cases situated similarly, and secondly, the need for India to evolve via this case.
The award is an important precedent: it signals that for changes made to policies retrospectively which have substantial effects on a company’s investment, the liability is of the country to make good the losses incurred. However, this precedent will apply only to cases where a) There was a BIT in place, and its violation has been alleged, and b) Tax matters were not explicitly excluded from the ambit of the BIT. Whether the retrospective amendment was itself illegal and in breach of the FET clause will soon be answered in the case of Cairn/Vedanta.
While India is duty-bound to avert tax evasion and enact measures it deems to be in its best interests first, it is also duty-bound to adhere to its treaty obligations. India can appeal this award in Singapore, the seat of the arbitration, however the authors believe it is time to wave the white flag and smoothen out the creases so that such situations do not arise again. This requires a comprehensive revaluation and restructuring of India’s existing treaties, and adopting fairer, more equitable tax and investment policies that are favourable to domestic as well as foreign investors.
[[i]] Arush Mittal - The author is a student at Hidayatullah National Law University, Raipur. He has previously worked as a Research Assitant to Dr Kabir Duggal regarding investment arbitration in India. He is also an editor at the blog of the Progressive Constitutional Law Society- HNLU Chapter. Mehak Jain - The author is a student at Hidayatullah National Law University, Raipur. She is an associate editor at Corporate and Commercial Law Blog, HNLU. ADR and Corporate Law piques her interests. Preferred Citation –Arush Mittal and Mehak Jain, “Vodafone v. India: Time to wave the white flag (?)”, Arbitration & Corporate Law Review, Published on 16th November 2020.
This article is reviewed by Arnav Maru and Yagnesh Sharma
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