FDI in Indian economy

For Cairns dispute, international arbitration is not the way forward

Note4Students

From UPSC perspective, the following things are important :

Prelims level : BITs

Mains level : Paper 3- Cairn Energy case

Context

The recent move by Cairn to seize India’s sovereign assets in order to enforce its arbitration award has brought into focus the dispute and the related issues.

Utility of Bilateral Investment Treaties (BIT)

  • After the World Wars, as more countries gained sovereignty, they tended to look at foreign investments as a form of neo-colonialism.
  • Bilateral investment treaties became the primary tool to forge relationships between developed and developing countries.
  • The BITs help to adopt standards for prompt, adequate and effective compensation in case of expropriation.
  • With the advent of globalisation, BITs became the means for foreign investment in developing countries.
  • Although the impact of investment agreements on foreign investments remains highly contextualised and inconclusive, these came to govern international investment relations.
  • The BITs retained the old-world construct that allowed international arbitration.
  • However, many developing countries view arbitration of tax matters as a breach of their sovereign right to tax.

The Cairn Energy case

  • In 2012, explanations were added to the Income Tax Act 1961 — these provisions were deemed as having a retrospective effect.
  • This was more in response to the Supreme Court’s decision in the Vodafone case which denied the income tax department’s assertion of tax claims arising from the offshore transfer of interest that substantially derived their value from India.
  • The 2012 explanations to the IT Act indeed sought to fix tax avoidance. 
  • Looking into the details of the Cairn case, one can see the series of reorganisations that tip-toed around tax laws of multiple jurisdictions, resulting in the non-payment of tax. 
  • Taxing offshore indirect transfers — a structuring device to gain tax advantage from the indirect sale of assets — is not unique to India (336 tax treaties contain such an article).
  • It is also possible to see that the underlying assets of the subsidiaries were immovable assets in India.
  • The UK-India tax treaty allowed for taxation of capital gains as per Indian law.
  • India challenged the admissibility of the case before the arbitration tribunal.
  • However, the case rests on a distinction between tax and tax-related investment.
  • Surely, all investments have tax implications and the acceptance of such a distinction could create problems even where tax is explicitly carved out from the bilateral investment treaties.
  • The option of arbitration upon an unsuccessful Mutual Agreement Procedure (MAP) resolution is not available in India.
  •  For this reason, over the years, there has been a rising trend in tax disputes involving BITs.
  • The Cairn case is one such instance where arbitration was invoked especially since MAP was not an option.

Way forward

  • The case raises many questions that administrators must address through reform.
  • India’s model BIT introduced in 2016 rectifies the issue of the distinction between tax dispute and investment-related taxation dispute through the specific exclusion of taxation.
  •  The recognition of a tax-related investment dispute, distinct from a tax dispute, should not undermine such a carve-out.

Conclusion

It is also important to note even if the award is enforced, the matter of tax avoidance stands pending before the High Court. Given the complexity, the only reasonable solution would be a negotiated settlement. Even if there’s a resolution in the Cairns case, questions of law would remain.

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