India and Cairn Energy on retrospective taxation

GS-Paper-2 International issues, Bilateral Investment Treaties (PT-MAINS)

GS-Paper-3 Tax Terrorism, Retrospective taxation (PT-MAINS)

• The Permanent Court of Arbitration at the Hague ruled in the favour of Cairn Energy over a retrospective tax demand worth Rs. 24,500 crore pursued by India’s tax officials since 2014.
• It has ruled that the tax levy falls contradiction of the India – UK Bilateral Investment Pact.
• This hearing is similar to the Vodafone case which India lost. But unlike the Vodafone case, where the Government had only Rs. 80 crore at stake if defeated, this verdict includes a shapr $ 1.4 billion payable as damages to Cairn.
• The damages arise from tax authorities’ decision to take by force and subsequently sell the company’s shares and freeze dividend payments as well as tax refunds, to recover the disputed tax dues even as the arbitration process was under way.
• This outcome has repercussions, not in the least for an arbitration plea filed over the same tax demand by Cairn’s parent firm, Vedanta, whose verdict is awaited.
• India has challenged in a Singapore court the international arbitration tribunal verdict that overturned its demand for Rs. 22,100 crore in back taxes from Vodafone Group. Similar challenge is expected in Cairn case.

About Bilateral Investment Treaty

• Bilateral investment Treaties (BITs) or Bilateral Investment Protection Agreements (BIPAs) are agreements between 2 countries for the reciprocal promotion and protection of investments in each other’s territories by individuals and companies situated in either State.
• They provide treaty based protection to foreign investment.
• Though they are signed by governments, their beneficiaries are business entities.

India brought a new Model Bilateral Investment Treaty (BIT) in 2016 effective from 2017.

Why the new model BIT?

1. The most important reason was the constant suing of the country by foreign firms. India was one of the most sued country during 2015 and 2016. According to UNCTAD- the international institution that tracks global investment trends, around 17 investor-state arbitrations are filed against the country launched by foreign investors by the end of 2015.
2. The government thus has modified the existing 1993 BIT framework and brought out the 2015 Model BIT.

What are the highlights of the new Model BIT?

1. Enterprise based definition of investment instead of asset based definition

• The Model has adopted an ‘enterprise-based’ definition of investment that under which investment is treated as the one made by an enterprise incorporated in the host state.
• Under the earlier ‘asset based definition’ of investment included intellectual property and other assets that whereas these assets are not considered as assets under the new definition.
• The objective of adopting enterprise-based approach is to narrow the scope of protected investments and reduce the potential liability of the state under Investor-state dispute settlement (ISDS) claims.
• Asset based definition considers every kind of asset – both movable and immovable as investment and gives protection under treaties, though their contribution to national economic development is meagre.

2. MFN treatment is excluded

• The new model dropped the Most Favoured Nation (MFN) status previously included. Purpose of the MFN clause for the investors angel is to ensure that a say, a US investor is not discriminated compared to say, a Japanese investor.

3. Full Protection and Security (FPS): In the context of the Model, FPS means obligations only relating to physical security of investors and to investments.

4. State government as stake holders: Actions of the state Governments are included under the Model BIT.

5.  Fair and equitable treatment (FET)

• The Model BIT links Fair and Equitable Treatment to international laws.
• This is aimed to counter a broad interpretation and risk misuse.

6. Expropriation

• Expropriation means nationalization of assets of foreign companies.
• As in other BITs, the Model BIT provides that the State cannot nationalise or expropriate an Investment or take measures equivalent to expropriation, except “for reasons of public purpose” in accordance with the procedure established by law and on payment of adequate compensation.
• But it gives certain exemptions. Here, the Model BIT says that, any measure by a judicial body aiming to protect public interest will be outside the purview of expropriation. Similarly, non-discriminatory regulatory measures were also excluded.

7. Non-Discriminatory treatment

• The Model BIT includes a new clause on non-discriminatory treatment for compensation of losses.
• As per the clause, investors can avail non-discriminatory just compensation in circumstances like armed conflict, natural disasters and in the state of national emergency.

8. Provision for transparency

• The Model BIT incorporates a clause for transparency, requiring the Parties (government and regulators) to ensure that all the laws, regulations, procedures and administrative rulings regarding matters covered in the BIT are published or are available for interested persons to get acquainted with them.
• The clause thus ensures clarity of laws and policies for the investors.

9. Corporate Social Responsibility:  The Model BIT mandates foreign investors to voluntarily adopt internationally recognized standards of corporate social responsibility.

10. Conditions for initiating arbitrations at international arbitrations

• The Model BIT stipulate that the aggrieved investor should use all local remedies as well as negotiations and consultations initiating arbitrations against the host State. Investor can use outside remedies only five years after resorting to all domestic arrangements.

11. The model BIT approved by the cabinet excludes matters relating to taxation.

• The model Bill thus tries to balance protection to the investor with state regulations. More importantly it was configured in the context of excess legal arbitration against the state.
• What is more important is to renegotiate with the partner countries and attract foreign investment in the context of the change.