Not everything is lost: long awaited decision in Vodafone Arbitration Case

Dated: October 07, 2020

                                                                                                                                      - By Megha Bhatia

By putting limits on their own strength, strong states grows stronger; weak states become weaker by falling into arbitrariness. India has to choose what it would like to be.

In its long pending case, the Permanent Court of Arbitration (PCA) in The Hague ruled in favour of Vodafone Group Plc against the Indian income tax department’s tax liability claim for Rs 22,100 crore, which dates back to the year 2007.

On September 25, 2020, the International Arbitration Tribunal ruled that the attempts of the Indian Government to claim more than 20,000 crore in Vodafone’s tax (including relevant interest and penalties) using retrospective legislation were in direct violation of the ‘fair and equitable treatment(FET)’ provision provided under Article 4(1) of the Bilateral Investment Treaty signed between India and Netherlands. Therefore, India is under an obligation to cease the conduct in question (infringement of FET), the PCA warned, failure to comply with which will engage “international responsibility”.

This brings to an end a decade-old saga which tarnished the image of India among foreign investors. Although much of the blame for this mess belongs to the previous coalition led by the Congress Party, Team Modi still had six years to end this debacle. Ending “tax terror” was also the pledge of his party in the 2014 election that took Modi to power.

The Tax Dispute

The Amsterdam-based subsidiary of the UK-based Vodafone group, Vodafone International Holdings (VIH), then entered into an agreement with Hutchinson Telecommunications International Limited (HTIL), a Hong Kong-based company. VIH acquired a Cayman Islands-based company called CGP Investments (Holdings) Ltd, a subsidiary of HTIL, pursuant to the agreement. Around 52 percent of the share capital of Hutchinson Essar Limited (HEL), an Indian firm, was held by CGP. The transaction resulted in VIH becoming the owner of CGP, and through it, HEL.

The object of this deal, according to the income tax department, was to acquire a 67 percent controlling interest in HEL. Accordingly, the Department tried to tax capital gains resulting from the selling of CGP’s share capital on the grounds that the underlying Indian assets are owned by CGP, but not by a tax resident in India. The demand for tax in 2012 was Rs 11,000 crore.

Although the High Court of Bombay (by a bench chaired by Justice D.Y. Chandrachud, currently a Supreme Court judge) ruled in 2010 in favour of the IT department, it claimed that the object of this transaction was to pass the controlling interest in HEL. In 2012, the Supreme Court reversed the decision of the high court, claiming that the transaction involved sale of shares rather than the sale of assets.

An Amendment to the Income Tax Act, 1961

In March 2012, the Supreme Court’s judgement prompted the Centre’s amendment to the Income Tax Act to provide that income from the selling of shares or units is considered to have accumulated or arisen in India if the transaction occurred outside of India and that its value depends primarily on the assets in India. The amendment came in the form of Finance Bill, 2012 empowering the income tax department to levy capital gains tax on transactions such as the acquisition of Vodafone, and do so even with respect to transactions that occurred prior to the amendment and as far back as 1961. The amendment essentially overruled the decision of the Supreme Court, restoring Vodafone’s tax liability. There was no choice left for Vodafone but to pursue International Arbitration.

The Award

The arbitral tribunal has ruled that Vodafone is entitled to the immunity afforded under the treaty in respect of its investments in mobile telecommunications in India. Notwithstanding the judgement of the Supreme Court, India’s actions with regard to the imposition on Vodafone of its claimed responsibility for taxes and the imposition of interest and penalties was found to be in violation of the terms of the guarantee of fair and equal treatment provided for in the Treaty. It was therefore held that this meant that India would cease to impose a retrospective tax and that any failure to comply with it would impose international liability on India.

Although no compensation was sought from the Indian government, it was requested to pay about Rs 40 crore as a partial compensation for the legal cost and to refund the tax collected so far. However, provided that the seat of arbitration was in Singapore, the Indian government can still approach the High Court of Singapore asking it to set aside the arbitral award.

It is important to note that, in deciding the case in favour of Vodafone, the Supreme Court observed and stressed that:

‘FDI flows towards the location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system.’

The future steps

The Government of India has said it is in the process of ‘considering all alternatives’ with media reports stating that the award is likely to be challenged. In other pending investment treaty disputes, this award will have implications for India and will have consequences for other claims, particularly in the context of retrospective tax disputes. In this case, the tax collection as sought was almost zero, so there does not seem to be a requirement for India to repay any significant sum other than the costs.

India is currently signing BITs either based on the 2016 model with an extremely restrictive ITA clause, or which do not have ITA provisions at all, such as the BIT between India and Brazil. Nevertheless, for the next 10-15 years, even the BITs that India has already terminated will continue to shield foreign investors. Therefore, it will do well to ‘internalize’ foreign investment law and BITs as a matter of strategy, as India does not seem to disengage itself completely from foreign investment law. More than ever, the Vodafone dispute highlights this need.

Whatever measures the government takes it may affect foreign investors, the obligations which it has agreed to under the BITs, must be taken into account. This requires the coordination of all ministries and departments with the Ministry of Finance, which is the nodal ministry of BITs and related matters. Sustained inter-ministerial cooperation is necessary, not after the implementation of the ITA case, but even before, when a governmental action is considered that could potentially impact foreign investors. This will also include capacity building and training in foreign investment law for government officials.

Now, as India reacts and deals with this unanimous award passed by a neutral international tribunal, it will more likely give signals to the international investment community, which will closely watch the government’s next move as it could affect their investment decision in India.


Top Stories