Financial Express: Tax matters: The Cairn conundrum and the future of tax arbitration
By Mukesh Butani & Aparna Raman
The arbitration ruling by the Permanent Court of Arbitration (PCA) in the Cairn Energy case, coming just three months after the Vodafone ruling, is testimony that jurisdiction is and will remain the primary issue of contention in international tax law. The applicability of withholding tax on capital gains arising from the transfer of underlying capital assets in offshore transactions, in particular, has been a matter of continuing controversy in India ever since Vodafone first challenged Revenue’s stand before the Bombay High Court in 2007. It eventually culminated in a historic decision by the Supreme Court of India in January 2012. What followed thereafter was retrospective amendments to various sections of the law to overturn the apex court’s verdict, resulting in both Vodafone and Cairn seeking protection under India’s Bilateral Investment Treaties (BIT) with the Netherlands and the UK, respectively.
With the Cairn ruling, the same set of questions, barring the jurisdiction for appeal, that arose after Vodafone will have to be reviewed and re-examined: Will India yield to/accept the tribunal’s ruling and restore the equilibrium arising out of the Supreme Court’s 2012 judgement, having legislated a retrospective law with a validation clause or will it continue with its assertion that tax is a sovereign entitlement and the Indian Parliament does not concur with the Supreme Court’s view, which it had reversed retrospectively? The government is already on record that it is beyond the arbitration panel’s prerogative to adjudge the scope of national tax laws. In the wake of recent awards, the government would additionally scrutinise the repercussions of accepting the tribunal’s order and its implications on other arbitrations.
In the Indian context, balancing domestic with international laws is not simply a question of sovereignty versus investor rights but also of striking a reasonable balance between national revenue or fiscal policy objectives and long-term investment or economic interests. While the jurisdictional source of international law arises from specific treaties or conventions and customary law, it can impose jurisdictional limitations as well. For instance, Article 2.4 of India’s 2016 Model BIT has a carve-out clause for taxation, according to which the treaty does not apply to any law or measure regarding taxation, including measures taken to enforce taxation obligations.
Generally, though, the territoriality principle, recognised in international law and treaties, is based on the subject-matter of the dispute, similar to the grounds of “specific jurisdiction” under the US law. It is also the most applied basis of jurisdiction under civil law systems (such as Article 46 of The French Code of Civil Procedure). Both Vodafone and Cairn essentially boiled down to challenging the extra-territorial reach (and right to tax) under domestic law. India neither had (prior to the 2012 amendment) any statutory tax law nor any judicial precedent qua withholding tax or taxation of an offshore transaction between two non-resident entities. And yet, as part of the PCA proceedings, India chose an interpretation under its domestic law which goes against the grain of both the India-Netherlands as well as the India-UK BIPA. Not surprisingly, the international tribunal has viewed the potential breach of legally-binding international investment treaties as having serious implications under public international law and global FDI norms. However, objections on the issue of its jurisdiction could extend to the appeal filed by the Indian government in the Singapore High Court against Vodafone.
The most telling difference between the two arbitration cases lies on the quantum of damages. While in the Vodafone ruling India has not been directed to pay any compensation, other than reimbursement of legal costs in addition to the refund of tax collected so far, the Cairn verdict, prima facie, imposes penal or punitive damages. Now that the government has challenged the Vodafone arbitral award, it can be expected that the Cairn ruling will also be challenged in the same manner before the Dutch Court. In the meantime, handing over an oil and gas field (surrendered or to be surrendered by the operator), a proposition being considered by the government, seems to be a sensible manner to comply with the international tribunal’s decision without further loss of taxpayer money or adverse impact on foreign investors.
With respect to foreign inbound investment into India, certainty, as the rule of law, will continue to be indispensable, every investor will rely upon, both before and after investing. Having said that, prospective investors would need to factor the Model BIT for new investments, given that investments made at the time when BIT was in vogue will continue to be grandfathered. This, coupled with a dynamic tax environment, entails a careful evaluation of options and a calibrated decision.
It is important for foreign entities to also note that international investment treaties (BITs) can have interpretations that limit the scope of their applicability, determine the qualifying requirements of the investment and standards of treatment, or adopt certain implied conditions depending on purpose and context. In case of such disputes related to tax based on an international investment transaction, the tribunal is well within its jurisdiction to recognise the need for restraining the sovereign or providing restitution.
From the first challenge to a retrospective amendment on an excise duty promulgated by the Finance Act, 1951, to the McDowell and Azadi Bachao judgments, up until Vodafone in 2012, India’s highest judiciary has consistently upheld the rules and tests for what constitutes fair and equitable taxation. The SC has followed legal form and substance over (contemporary) economic form and substance, thus, granting legitimacy to tax planning. The situation stands altered though with General Anti-Avoidance Rules of 2017, which will be tested by the GAAR panel before going to Court.
The decision of the international tribunal in both Vodafone and Cairn also goes to show that the SC judgment is in concurrence with international jurisprudence. Clearly, the doctrine of contemporanea exposito still holds good not just for the interpretation of domestic tax law but also double-tax treaty law.
In fact, notwithstanding the challenge of the government in the SIAC, it remains to be seen whether Cairn will be able to effectively enforce the arbitral award, given that the rulings of the Delhi HC so far have held that there is no scheme (at present) under the Arbitration & Conciliation (A&C) Act, 1996, for enforcing awards based on international treaties. Moreover, Section 48(2) provides the courts with full judicial discretion to refuse enforcement if enforcing such award is contrary to the ‘public policy of India’. This has been a continuing gap in the legislation, though the SC’s decision in the Ssangyong and Shri Lal Mahal cases and, most recently, in the Vijay Karia case on what constitutes public policy grounds to refuse enforcement indicates a lesser likelihood of foreign arbitral awards being refused to be enforced. We find that courts, particularly the SC, have yet to consider the policy implications of a foreign arbitration award that imposes damages on a sovereign government for seeking to tax a foreign investor with retrospective effect.
Though we are yet to hear the final word on both Vodafone and Cairn, it will be prudent to clarify the status of foreign arbitral awards, including their enforcement, by way of a government notification with respect to section 48 of the A&C Act, bearing in mind the long-term interests of India’s investment policy in the years ahead.
Mukesh Butani is founder and managing partner, BMR Legal. Aparna Raman is a corporate lawyer and legal policy advisor