Arbitration and taxation have recently become key topics in the global news, particularly regarding the case of Indian government’s retrospective tax on energy giant Cairn Plc. The Permanent Court of Arbitration (PCA) has ruled that the move was unjustified. This came three months after India lost a similar arbitration case to Vodafone Plc over retrospective tax legislation amendments.
Background of the Case
The origin of this dispute dates back to 2006-07 when Cairn UK transferred shares of Cairn India Holdings to Cairn India. The Income Tax authorities then slapped a tax demand of Rs. 24,500 crore on the transaction, contending that capital gains had been made by Cairn UK. On the grounds of different interpretations of capital gains, Cairn UK refused to pay the tax, leading to cases being filed at the Income Tax Appellate Tribunal (ITAT) and the Delhi High Court.
In 2012, the Indian government amended its budget retrospectively, granting itself the power to investigate mergers and acquisitions dating back to 1962 if the underlying asset was located in India. In retaliation, Cairn Energy Plc initiated international arbitration proceedings against the Indian government in 2015.
The PCA Ruling
The recent PCA ruling has ordered the Indian government to pay around Rs. 8,000 crore in damages to Cairn. It was clarified that the Cairn tax issue is not just tax-related but also an investment-related dispute, bringing it under the jurisdiction of the PCA. The court found that the retrospective demand levied by the Indian government breached the guarantee of fair and equitable treatment. The Centre failed to uphold its obligations under the UK-India Bilateral Investment Treaty and international laws, by seeking tax payments from the company for its business reorganisation in India.
India’s Position on the Ruling
Post the verdict, the government stated that it will study the award and all its aspects carefully, in consultation with its counsel. Following these consultations, the government will weigh all possible options and decide on the future course of action, which may include legal remedies before appropriate fora.
Understanding Retrospective Taxation
Retrospective taxation is a measure that allows a country to tax certain products, items or services and deals from a time prior to the law being passed. This route is usually taken to fix anomalies in taxation policies that have previously allowed companies to exploit loopholes. However, such a measure can negatively impact companies that interpreted the tax rules differently, either knowingly or unknowingly. Various countries including the USA, UK, Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies apart from India.
About the Permanent Court of Arbitration
Established in 1899, the PCA is an intergovernmental organization headquartered in The Hague, Netherlands. It serves the international community in the field of dispute resolution, facilitating arbitration and other forms of dispute settlements between States. The organizational structure of PCA comprises an Administrative Council for policy oversight, Members of the Court, and International Bureau, its secretariat. It also hosts a Financial Assistance Fund to assist developing countries in managing costs of international arbitration.
Moving Forward: Need for Clear Dispute Resolution Mechanisms
Creating an investment-friendly business environment will boost economic activity and help generate more revenue over time for the government. There is a critical need for political support to curb tax officials’ attempts to cling onto legally untenable revenues. To avoid such disputes from reaching international courts, India needs to devise precise and clear dispute resolution mechanisms in cross-border transactions. Enhancing the arbitration ecosystem will positively influence the ease of doing business.
Last Modified: February 9, 2024