Case Analysis on Cairn v. India: International Commercial Arbitration with special reference to United Kingdom-India Bilateral Investment Treaty
Background
On January 20th 2012, the Supreme Court of India gave its verdict in the Vodafone case. The case was regarding tax invasion in regards to capital gains in lieu of sale of shares. The court held that such sale of shares shall not be regarded as transfer of a capital asset as given under Section 2(14) of the Income Tax Act. Court discharged Vodafone international Holding BV of tax liability of INR 120 billion, further it ordered the income tax department of India to refund INR 25 billion which was earlier deposited by Vodafone as directed under an interim order on November 26 2010, the apex court further ordered to pay the deposit amount along with interest at 4% per annum within 2 months.
Tax Legislation
Pursuant to the Supreme Court verdict which was against the interest of the Income Tax Authority and government of India, the parliament passed the finance act 2012 in March 2012. In this act, the law makers inserted two explanations.
First explanation was in regards to meaning of the term ‘through’, it stated that “the term ‘through’ shall mean and include and shall be deemed to have always meant and included by means of, by reason of, in accordance to”.
Second explanation stated that “an asset or a capital asset which shall include share in a company incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India if those shares derive value substantially from assets situated in India directly or indirectly”.
Facts
As a result of the 2012 amendment, the AO, under sections 147 and 148 initiated reassessments proceeding against Cairn UK Holding Limited (CUHL). The AO stated the reason of non assessment of income to initiate proceedings. The income tax department sought information on a transaction related to share transfer that was made in 2006. The department claimed that it had identified that income had gone unassessed in a certain transaction. It further said that the transaction was linked to the IPO of Cairn India Limited in 2007. Moreover, it stated that the reassessment was also in lieu of the 2012 amendments made by the parliament, it cited the reason that 2012 amendment was retrospective in nature and hence the reassessment proceedings could be initiated.
On March 9th 2015, draft assessment order was passed against Cairn UK Holding Limited wherein a tax liability was made out, the order stated that Rs 102 Billion worth of principal tax was due on the 2006 transaction carried out by CUHL, moreover, interest and penalties were also applicable along with the principal tax.
CUHL decided to appeal the order before Income Tax Appellate Tribunal, Delhi. However, the ITAT, on March 9, 2017 upheld draft assessment order. CUHL further filed an appeal in the Delhi High Court.
Share Transfer Transaction
For the purpose of Establishing a corporate structure and share valuation purposes and stake sale purpose for planned IPO in 2007, slew of structural changes and transactions were carried out in 2006.
In August 2006, Cairn India Holding Limited was incorporated in Jersey. It was incorporated as a subsidiary of Cairn UK Holding Limited. This holding company was incorporated in June 2006, in the United Kingdom.
Later on, a share transfer agreement was entered into by CUHL and CIHL wherein CUHL transferred shares of 9 subsidiaries of Carin group to CIHL, this included transfer of entire share capital of all subsidiaries. These subsidiaries were engaged in oil and gas sector in India.
During the same period, in August 2006, Cairn India Limited (CIL) was incorporated, this was a subsidiary of Carin UK Holding Limited (CUHL). Later on, in October 2006 CUHL sold the shares of CIHL to CIL. The consideration in this transaction was cash and shares of CIL. In December 2006, the company had its IPO wherein 30.5% stake was divested. In this transaction, CUHL received Rs 6,101 Crores from proceedings of the IPO.
In December 2011, Vedanta Resources, incorporated in UK acquired 59.9% of CIL, later on in April 2017, CIL merged with Vedanta ltd, a company incorporated in India and a subsidiary of Vedanta Resources. Cairn energy, subsidiary of Vedanta Resources received ordinary and preference shares of Vedanta ltd.
Invocation of India- UK BIT by CUHL and Vedanta UK
On March 10 2015, soon after the draft assessment order was passed, Cairn Energy initiated International arbitration proceedings by relying upon the India- UK BIT. It claimed restitution to all penalties and orders passed against them. Further, it requested to order assurance of fair and equitable treatment and protections against expropriation.
The arbitration proceedings commenced in January 2016. Statement of claims was filed in June the same year. During the pendency of ongoing arbitration, the income tax department seized and sold the shares of CUHL in order to recover part of tax demanded and thus realized USD 216 million. Due to all this exercise of the tax department, CUHL pleaded they were treated wrongly and that it should be compensated by India and that actions taken against it were illegal. They prayed before the tribunal that they should be restored to their position as it was in 2014.
On December 21 2020, the tribunal held that India had failed to honour its obligations under the Ind-UK BIT of 1994 and hence ordered India to compensate Cairn for the losses incurred due to India’s actions.
Breach of BIT
There was BIT between the India and United Kingdom and is an agreement that is made to promote and protect the investment. The BIT was signed in the year 1994 and main purpose was to “create the favorable conditions for fostering greater investment by investors of one state in the territory of other State”. As stated earlier that the case is about tax dispute This case also deals with the breach of BIT between India and United Kingdom.
In the following case, due to 2006 transaction and retrospective taxation by the tax authorities, so Cairn Energy had initiated arbitration process in the year 2015 as stated that there was breach of India-UK BIT and rules to followed were of UNICIRAL Rules of Arbitration, 1976. In the Arbitration, the Cairn Energy claimed for the compensation for the breaches under the India-UK bit as they claim that India has failed to provide the favorable conditions i.e. FET clause of the BIT for the investment of the Cairn Energy. Second claim of Cairn Energy was that under the “Article 3(2)[1]” of the India-UK BIT, India failed to give their investment under the “Article 3(2)”. Third claim was that India has expropriated the Cairn UK Holdings Ltd. investments and has not provided the compensation for expropriating. Fourth claim was that they have also violated the “Article 7[2]” of the India-UK BIT as to they have breached the right of unrestricted transfer of the investments or returns.
India in return replied and also objected that the tribunal has no competent jurisdiction to try the arbitration. India’s reply to the claims of the Cairn energy were that under the India-UK BIT, Cairn India’s assets did not qualify as the investment as stated under the “Article 1(b)” of the BIT. The reason being that Cairn UK Holdings Ltd. investment was not made by keeping in mind the India Law in the year 2006, as the transaction was made with respect to avoid the tax scheme and it violated the Indian laws at that time and also stated that the claims of the Claimants should be dismissed as 2012 Amendment did not breach UK-India BIT because they are retrospective as retrospective application are lawful in India. Under the “Article 9” states about the returns on the investments and not the investments solely under the UK-India BIT. India also relied on the “Article 5(3)” of the BIT, that has given the guarantee for the compensation for expropriation and stated that it is a tax measure that is falling under the powers given to the police and that would not be expropriation of the investments under the “Article 5(3)” of the BIT and it is state’s one of the sovereign function to implement the tax measures. Further to support their claim they relied on the “RosInvest” case[3] which dealt with similar provision of the expropriation. India in their claims also stated that the tax disputes are not the subject matter that are in the scope of UK-India BIT. They even argued that claimants have violated the Indian securities regulation which are SEBI DIP Guidelines.
Recent developments in the case
In the International Arbitration between Cairn UK and India the arbitral tribunal had ruled in the favour of investor Cairn and it was seen as an embarrassment for the Indian tax authorities. This Arbitration for India was also coupled with the other case of Vodafone wherein the tax authorities were applying the GAAR provisions retrospectively. Both the cases are concerned with the taxation but the Cairn dispute has the far reaching consequences in the aspect of the Ease of doing business as the UK India BIT is in dispute and at large the common investor sentiment is at stake.
After Indian claim was rejected and the award amounting to $1.4 Billion was awarded to Cairn following this the government was found on the sticky wicket as there was the pressure on it in the case of the economic slowdown due to COVID and the investment friendly perception to be established in order to attract the investments from the foreign investors. The news report suggested earlier in the year 2021 that the government may think of giving them the stake in the refinery in Rajasthan.[4]
Later on the developments emerged that the arbitral award passed by the arbitral tribunal. India filed an appeal against the Cairn Energy arbitration verdict at The International Court of Justice Permanent Bench at Hague on Monday night, challenging the $1.2-billion award on grounds of sovereignty and tax avoidance by the UK oil major.[5]
Cairn was unmoved by this appeal filed by the Indian authorities against the International Arbitration and had planned to file the individual suits for the enforcement of the award ad seizure of Indian assets in foreign countries. The appeal by India had no effect on the Arbitral Award and Cairn was in its full rights to get the enforcement of the Arbitral Award. The Indian assets of the PSUs and the Indian government were to be seized as they had claimed in the US courts for lifting of the corporate veil as the assets of the PSUs are controlled and managed by India and the PSU are the state instrumentality in itself.
Conclusion
The Cairn v. India dispute was the investment dispute which has cost India the bad repute and the negative perception which the is unwary of any investor friendly nation. The dispute was due to the BIT which had been broad ended and the proper interpretation of the same was hard to be ascertained. The BIT of 1999 was old and the disputes involved were contemporary in nature. India cancelling the BIT in favour of the new negotiations is the welcome step and the disputes of this nature do bring India a bad repute and costs heavily even on the inflow of the foreign funds. This is essentially the issue which needs to be addressed in the coming days for attracting the better foreign investments.
[1] Article 3(2) of UK-India BIT- Investments of investors of each Contracting Party shall at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other Contracting Party.
[2] Article 7 of UK-India BIT-Each Contracting Party shall in respect of investments grant to investors of the other Contracting Party the unrestricted transfer of their investments and returns. Transfers shall be effected without delay in the convertible currency in which the capital was originally invested or in any other convertible currency agreed by the investor and the Contracting Party concerned. Unless otherwise agreed by the investor transfers shall be made at the rate of exchange applicable on the date of transfer pursuant to the exchange regulations in force.
[3] RosInvestCo. UK Ltd. v. The Russian Federation, SCC Case No. V079/2005.
[4] BIZ WRAP & Economy Politics, India may offer Cairn oilfield against $1.4 billion arbitration award Businesstoday.in (2021), https://www.businesstoday.in/current/economy-politics/india-may-offer-cairn-oilfield-against-14-billion-arbitration-award/story/429690.html (last visited Apr 13, 2021).
[5] Dilasha Seth, Govt files appeal against $1.2-billion Cairn arbitration verdict Business-standard.com (2021), https://www.business-standard.com/article/companies/india-appeals-against-cairn-arbitration-order-seek-stay-on-1-2-bn-award-121032301272_1.html (last visited Apr 13, 2021).
Author: Deep Hirani, Karan Shah, Milind Parikh
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