PCA TRIBUNAL FINDS INDIA IN BREACH OF TREATY IN VODAFONE TAX DISPUTE

The Government of India has lost the first of three keenly anticipated decisions on the retrospective tax liabilities introduced by statute in 2012 to reverse the ruling of the Indian Supreme Court in the Vodafone case.

The legislation was introduced in the Finance Act 2012 to reverse the Supreme Court’s ruling that Vodafone was not liable for capital gains tax under Indian law in respect of its acquisition of the Indian mobile phone business of Hutchison Essar Limited in 2007. That change in the law with retroactive effect was then used to levy some $2.2 billion of tax, interest on penalties on Vodafone, as well as subsequent demands on both Cairn Energy and Vedanta Resources in respect of a separate transaction also charged with tax, interest and penalties on a retrospective basis.

Vodafone commenced international arbitration in 2014 under the India-Netherlands bilateral investment treaty (BIT), asserting that the conduct of the Government breached the protections promised to investors under the treaty. After proceedings lasting some 6 years, the tribunal seated in Singapore under the auspices of the Permanent Court of Arbitration, has held unanimously in an award dated 25 September 2020, that India was in breach of the treaty. While the award has not been made public, media reports indicate that the tribunal found:

• It had jurisdiction over the dispute; contrary to India’s submissions, tax disputes were covered by the scope of the India-Netherlands BIT.
• India had violated the fair and equitable treatment guarantee under the treaty by retrospectively imposing tax, interests and penalties on Vodafone.
• India was directed to “cease the conduct in question”, and ordered to pay the majority of Vodafone’s costs, understood to be in excess of £4 million.

The result of the tribunal’s decision is that any further steps by the Indian tax authorities to collect the retrospective tax, interest or penalties would be a breach of India’s international law obligations under the treaty.

The decision on the tax demand on Vodafone precedes the decisions in two other international arbitration claims brought by Cairn Energy and Vedanta Resources in respect of demands for tax, interest and penalties levied on them under the same retrospective amendment to Indian tax law.  In the case of Cairn Energy, as well as challenging the tax demand, the company has also announced that it has asserted a claim for monetary damages of some $1.4 billion, based on the actions of the Indian tax authorities in 2014 to enforce the tax demand by seizing and then selling shares held by Cairn Energy in the Indian company, Vedanta Limited. Cairn Energy says that the sale took place at a low point in the value of the shares, which caused it substantial harm. Thus, while the effect of the decision in Vodafone’s case is largely declaratory (that the tax demand breaches India’s treaty obligations), the decision on the Cairn Energy case will also include whether India is liable to pay substantial damages for actions taken to enforce that separate tax demand.

The issue of retrospective tax has been a painful one for international investors and the Indian Government, as it seeks to attract foreign investment into India. Late former Finance Minister, Arun Jaitley, had said that he considered the retrospective legislation to have been an “erroneous decision”, and the Modi government ruled out the use of retrospective tax actions that may deter inbound investors anxious about the stability of the Indian business environment shortly after taking power in 2014.

The Vodafone award, and the two that will follow, will determine whether a line can now be drawn under the retrospective tax actions of 2012.

For more information, please contact Nicholas Peacock, Partner, Iain Maxwell, Of Counsel, or your usual Herbert Smith Freehills contact.