Editor’s Pick: A double blow on retrospective tax

(The Editor's Pick is a new newsletter from The Hindu that provides a snapshot of the most important stories from today's edition of our newspaper, along with a note from our top editors on why we chose to give prominence to these stories.)

Cairn Energy Plc, the U.K.-based global oil and gas major U.K. won a major relief on Wednesday as the Permanent Court of Arbitration at The Hague ruled that the Indian government’s retrospective tax demand against it was “inconsistent” with the UK-India bilateral treaty. The tribunal also ruled that India’s demand of $1.2 billion in retrospective tax was “in breach of the guarantee of fair and equitable treatment”.

The tribunal ordered the government to desist from seeking such a tax and return the value of shares it had sold, dividends seized and tax refunds withheld to recover the tax demand. It ordered the government to return up to $1.4 billion to Cairn Energy Plc, as compensation for ‘total harm suffered’ among other things.

This is the second major arbitral setback to India in three months over its position on retrospective taxation. In September 24 this year, the Permanent Court of Arbitration at the Hague had ruled that the Indian government’s ₹22,100-crore retrospective tax demand against telecom major Vodafone was also in “breach of the guarantee of fair and equitable treatment” under the bilateral investment protection pact between India and the Netherlands.

To recap: both the Vodafone and Cairn cases involve a transfer of ownership of an Indian entity by way of an overseas transaction involving parties which did not fall under Indian tax jurisdiction. In the Vodafone case, Vodafone International Holdings B.V., a Dutch company, acquired 67% of an Indian company, Hutchinson Essar Limited. In the Cairn case, as a part of internal rearrangement in 2006-2007, Cairn UK transferred shares of Cairn India Holdings to Cairn India. In both cases, the tax authorities argued that though the deal was between two overseas entities, the shares derived their value from assets held in India, and hence were liable for capital gains tax. After the Supreme Court struck down the demand for this manner of taxation in the Vodafone case the government then amended the law in 2012 to allow indirect transfers which derive substantial value from assets located in India to be subjected to tax.

These two high profile setbacks over retrospective taxation are not a good look for India at a time when it is trying to attract foreign investment. The wording of the tribunal order, implying that India does not play fair when it comes to tax policy is particularly damaging. India has an opportunity to challenge the arbitration court’s order in the Cairn case as it does in the Vodafone case. Incidentally, the deadline for the latter is today, December 24. Senior officials from the Department of Telecommunication and Finance Ministry reportedly met to discuss this on Wednesday, but no decision was reached. India’s next moves on this may be crucial to determining whether it moves up or down on the much prized 'ease of doing business' index. That’s what makes this story important.

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