Tax Reforms

Explained: The Cairn Tax Dispute


From UPSC perspective, the following things are important :

Prelims level: PCA

Mains level: Cairn Issue

In December 2020, a three-member tribunal at the Permanent Court of Arbitration in the Netherlands ruled against India in its long-running tax dispute with the U.K.-based oil and gas company Cairn Energy.

PCA Ruling against India

  • The tribunal ordered India to pay about $1.4 billion to the company.
  • Following this, Cairn Energy has successfully moved courts in five countries, including the US and the UK to recognise its claim as per the arbitration award.
  • The Netherlands, France, and Canada are the other three countries.
  • Such recognition by courts opens the door for Cairn Energy to seize assets of the Indian government in these jurisdictions by way of enforcing its claim, in case the latter doesn’t pay its dues.

What is the dispute about?

  • The dispute started in early 2014 when Indian tax authorities started questioning Cairn Energy requesting information on the group’s reorganization in the financial year 2006-07.

Issue over the tax due

  • This escalated, and by 2015, the authorities had sent the company a draft assessment order, assessing in the process that there was a principal tax amount of $1.6 billion that was due.
  • The year in reference, 2006-07, was one in which big corporate changes and developments took place in Cairn Energy.

Basis of the tax demand: Sale of Shares

  • It was the year in which it not only undertook a corporate reorganization but also floated an Indian subsidiary, Cairn India, which in early 2007 got listed on the Indian Stock Market.
  • Through the corporate reorganization process, Cairn Energy had transferred all of its India assets, which were until then held by nine subsidiaries in various countries, to the newly-formed Cairn India.
  • But the tax authorities claimed that in the process of this reorganization, Cairn Energy had made capital gains worth ₹24,500 crores.
  • This, the department asserted, was the basis of the tax demand.

Is this case similar to Vodafone’s battle with the government?

  • The Vodafone case in 2007 was triggered by Hong Kong’s Hutchinson Telecommunications’ sale of its stake in India’s Hutchinson Essar to Vodafone based out of the Netherlands.
  • The Hong Kong firm made a capital gain on this, which the Indian tax authorities deemed fit to tax.
  • They held that Vodafone should have withheld the tax, and therefore imposed liability on it.
  • The Supreme Court quashed the taxman’s demand that the sale of shares, in this case, would amount to transfer of a capital asset within the meaning of Section 2(14) of the Indian Income Tax Act”.

What governs the Sale of Shares?

  • In the Union Budget of 2012, the Income Tax Act, 1961 was amended to make sure that even if a transfer of shares takes place outside India, such a transfer can be taxed.
  • This was done when the value of those shares is based on assets in India. And this was applied retrospectively.

Cairn won over Retrospection

  • The action against Cairn Energy was based on this move.
  • India lost its arbitration case against Vodafone as well, with the government being asked to fork out around ₹80 crores.

What happened after the tax claims in the Cairn Energy dispute?

  • After receiving a draft assessment order from the tax authorities, Cairn UK Holdings Ltd. appealed before the Income Tax Appellate Tribunal.
  • The tribunal, while providing the company relief from back-dated interest demands, however, upheld the main tax demand.
  • The company had initiated proceedings of arbitration under the U.K.-India bilateral investment treaty.
  • But during this time, the government sold Cairn’s almost 5% holding and seized dividends totalling ₹1,140 crore due to it from those shareholdings and set off a ₹1,590-crore tax refund against the demand.

What was the main argument of Cairn Energy during the arbitration?

  • The claimants, Cairn Energy and Cairn UK Holdings argued that till the amendment was made to tax retrospectively in 2012, there was no tax on indirect transfers.
  • Indirect transfers here meant transfer by a non-resident of shares in non-Indian companies which indirectly held assets in India.
  • The application of the 2012 amendments, they alleged, constituted “manifest breaches” of the U.K.-India bilateral investment treaty.

What was India’s defence during the arbitration?

  • India’s counter to the main charge of Cairn Energy was that its 2006 transactions were taxable irrespective of the 2012 amendments.
  • It argued that “Indian law has long permitted taxation where a transaction has a strong economic nexus with India”.
  • It said even if it is retrospective, it is “valid and binding applying the longstanding constitutional, legislative and legal framework in which the claimants have invested”.

What did the arbitration tribunal rule?

  • The tribunal said the tax demand violated the U.K.-India bilateral investment treaty.
  • The tribunal said India “failed to accord Cairn Energy’s investments fair and equitable treatment” under the bilateral protection pact it had with the United Kingdom.
  • It also ordered India to compensate Cairn Energy and its subsidiary for “the total harm suffered” as a result of the breaches of the treaty.

India’s way ahead

  • It has been reported in the media that India will appeal against the tribunal’s decision.
  • If enforcement proceedings are initiated, India is confident of addressing them and will strongly defend its interests.

Back2Basics: Permanent Court of Arbitration (PCA)

  • It is an intergovernmental organization located in The Hague, Netherlands.
  • It is not a court in the traditional sense but provides services of arbitral tribunal to resolve disputes that arise out of international agreements between member states, international organizations or private parties.
  • The cases span a range of legal issues involving territorial and maritime boundaries, sovereignty, human rights, international investment, and international and regional trade.
  • The PCA is constituted through two separate multilateral conventions with a combined membership of 122 states.
  • The organization is not a United Nations agency, but the PCA is an official United Nations Observer.

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