Vodafone may have won the day after a favourable arbitration result cut off India’s claim to massive back taxes, but will this crucial award remain unchallenged when so much more is at stake? Freny Patel reports
The decade-old legal battle between Britain’s telecoms major Vodafone and the Indian government over a tax dispute is expected to continue for many more years. Vodafone may have breathed a sigh of relief last month when it announced that the Hague-based Permanent Court of Arbitration unanimously ruled in its favour, “including India’s appointed arbitrator Rodrigo Oreamuno”, in the retrospective imposition of tax liability.
While the international tribunal held that any attempt by the government to enforce the tax demand would be a violation of India’s international law obligations, there are still uncertainties around the arbitral award. India may decide to challenge it, or resist its enforcement through the local courts, which would give rise to further court proceedings in Singapore, India and elsewhere for years to come, legal experts have speculated.
The likelihood of the government challenging the international arbitration award that favoured the UK telecommunications company holds some merit. After all, which sovereign state would wish to lose massive tax revenue on account of an arbitral award? Not to mention that this award sets a precedent for other similar upcoming cases, including that of Cairn Energy and Vedanta Resources.
The Permanent Court of Arbitration ruled that India’s attempt to impose a retrospective withholding tax demand of US$5.5 billion (including penalties and interest) on Vodafone was in violation of India’s obligations under the India-Netherlands bilateral investment treaty. It further ruled that any attempt by India to enforce its demands against Vodafone would violate international law.
While no compensation has been awarded to the UK telecom, the English court has asked the Indian government to pay about ₹400 million (US$5.4 million) towards the legal cost incurred and refund the tax collected thus far.
This particular saga started more than a decade ago, when Vodafone International Holdings acquired a 100% stake in a Cayman Island-based company, CGP Investments, for US$11.1 billion in 2007. CGP was a subsidiary of the Hong Kong-headquartered Hutchison Telecommunications International, and held 52% of the share capital in the Indian telecoms company Hutchison Essar.
As the deal took place offshore through the Cayman Island company, Vodafone refuted the Income Tax Department’s demands to cough up US$2.2 billion towards capital gains tax, stating that the transaction did not involve the transfer of any capital asset situated in India. This is because there was no tax withholding obligation in transactions between two non-resident entities.
“The law was very clear and there was no ambiguity of, nor any tax avoidance, by Vodafone,” said counsel and disputes expert Percival Billimoria, who is also head of Chambers, Chambers of PS Billimoria. “In the early 1990s, when India desperately needed foreign direct investment, investment through treaties incentivized foreign direct investment inflows,” he said.
A couple of decades later, however, the Indian tax authority was singing a different tune. It identified that transactions between two non-resident entities were designed to avoid capital gains tax in India and made demands on Vodafone.
When the Supreme Court upheld that Vodafone was not liable to pay any tax, stating that it was a share sale and not an asset sale, the government decided to put a stop to the “alleged abuse” and plug the loophole that allowed the indirect transfer of Indian assets. Amendments to the law with retrospective effect and a demand on Vodafone to pay the tax forced the UK company to contest the matter through international arbitration via the bilateral investment treaty route.
“The rollover effect of loss of confidence for the foreign investor post seeing India’s reaction to a favourable Supreme Court judgment left a sour taste,” says Bijal Ajinkya, a partner in Khaitan & Co’s direct tax practice group. “Foreign investors started looking for alternate jurisdictions to invest in other than India,” she adds.
It has been a roller-coaster ride for Vodafone, but the tenacity with which they fought the case successfully shows that the rule of law does prevail. “The Supreme Court verdict on Vodafone preceding the recent bilateral investment treaty award fortified the rule of law in India,” says Vodafone counsel Fereshte Sethna, the founder and managing partner at DMD Advocates, adding that the arbitral award is “justice for Vodafone” and an important validation for FDI into India.
Rabindra Jhunjhunwala, a Mumbai-based partner at Khaitan & Co’s, told India Business Law Journal: “Foreign investors tend to keep room for this tax in their deal negotiations. Any change in the tax law would only have a positive effect on the balance sheets of sellers, which have kept room for the indemnities provided to the buyers.”
Government’s course of action
The government is likely to reveal its stance as to whether it will challenge the award by 17 November, if not sooner, when it responds to the 7 October 2020 Delhi High Court division bench order demanding the government’s position on the arbitral award. The next hearing of the division bench, scheduled initially for 8 October and then 16 October, was postponed finally to 17 November because the additional solicitor general (ASG) was suffering from covid-19.
The matter had reached the division bench of the Delhi High Court after the government appealed a single bench judge’s refusal to pass an injunction against the arbitration in 2018.
In the 7 October order Vodafone’s counsel had been told that the government should, on the next date of hearing, inform whether it intends to be bound by the arbitral award or take up further proceedings. Judge Rajiv Sahai Endlaw said that it was deemed apposite that the ASG “obtains categorical instructions” from the government.
The government’s biggest worry, and possibly fear, is that Vodafone’s arbitration award victory could set a precedent for other companies to follow and seek damages or claims.
Both Sethna and Sumeet Kachwaha, founding partner of Kachwaha & Partners, who was amicus curiae in the Vodafone dispute case heard in the Delhi High Court, agreed that the arbitration award may well persuade other arbitral tribunals to rule similarly. “While a bilateral investment treaty arbitration is a remedy of last resort, the invocation of the remedy is not a matter to be treated lightly,” Sethna advised.
Nicholas Peacock, a London-based partner and head of the India arbitration practice at Herbert Smith Freehills, notes that “the Vodafone award, and the two that will follow – namely Cairn and Vedanta – will determine whether a line can now be drawn under the retrospective tax actions of 2012”. His firm has been advising Vedanta Resources on its US$3 billion claim against India under the India-UK bilateral investment treaty arising from the imposition of the retrospective tax.
Whether or not other cases benefit from the Vodafone decision will be decided on its own merits, Peacock says, against the framework of the relevant treaty. “Since the cases are also separate and generally confidential, there may also be difficulties with the separate tribunals seeing each other’s awards (assuming they do not become public),” he says.
Kshama Loya, leader investor-state arbitration at Nishith Desai Associates in Mumbai, says the Vodafone award may not influence the outcome in the Cairn Energy dispute, which is in its final stage. Hearings were completed in December 2018, and the arbitral award is expected anytime, she says. “In any event, arbitral tribunals are independent and their decisions do not have a binding effect on other matters.”
Cairn announced in July that while the arbitral tribunal is not able to commit to a specific date for its ruling, and had encountered some difficulties due to the covid-19 pandemic, significant delays are not expected. It hopes to remain reasonably within the lead-time it had anticipated, in terms of the “release of the award after the end of the summer”. Cairn continues to be confident and is seeking full restitution for losses of more than US$1.4 billion.
“While it is India’s sovereign right to pass and amend its laws, it is also a sovereign commitment of India to honour the bilateral investment treaty that it has entered into,” says Loya. “Going forward, India will need to expressly negotiate exclusion of taxation measures from the scope of the bilateral investment treaties to avoid disputes like Vodafone to some extent.”
India has already excluded taxation measures from the bilateral investment treaties it has signed in 2018 and 2020.
While the government contemplates its next course of action, Kumarmanglam Vijay, a Gurugram-based taxation advisory partner at J Sagar Associates, says that uncharted legal territories lie ahead for both the telecom company and the government, even after this final arbitral award. For Vodafone to get this award enforced in India may, in itself, be a bigger hurdle, he adds.
Similarly, if the Indian government were to challenge this award in a Singapore Court, which was the seat of this arbitration, it may again have to convince the court that a change in law applies to all taxpayers alike, and that “the government’s domestic taxation sovereignty is not curtailed by the bilateral investment agreement”.
Billimoria is of the view that, due to arbitration awards being “declaratory, pursuing the claim against Vodafone would be a breach of international obligations”. He highlights a proposal initiated by the US that, instead of state arbitration, a new court system may be preferable.
Peacock says that, “Though there are potential avenues for a losing party to seek to ‘set aside’ an award, the grounds for doing so will depend on the specifics of the award and the proceedings”.
The billion-dollar question is whether India will lose face by challenging the award, since the present government had categorically stated that it would not introduce any retroactive laws, and this was a direct reflection on what their predecessors had done vis-à-vis Vodafone, says Jhunjhunwala. “This is a telling test of whether India truly believed in their political propaganda,” he says.
“Enforcement of the award in India could be a tough battle, owing to the uncertainty in the legal framework applicable to investment treaty arbitrations in India,” adds Loya. “It has been held by Delhi High Court that the Arbitration and Conciliation Act, 1996, does not apply to investment treaty arbitration. This could pose hurdles for Vodafone.” Although the arbitration was brought about due to the retrospective element of the tax law by the former government, the current government will need to ascertain what is in its best interest. It is not a question of loss of face, but one of whether the arbitration award encompasses the taxation powers of the government.
Some element of clarity in terms of enforcement of the award may prove necessary. If the government chooses to contest the award, it will first need to take leave of the Hague-based Permanent Court of Arbitration, and then contest it at the Singapore High Court, as Singapore is the seat of arbitration.
“It is possible for the government to challenge the award on limited grounds in Singapore,” says Loya, identifying one of the grounds to be that the dispute was not capable of settlement through arbitration. However, much depends on the reasoning mentioned in the award, which currently has not been made public.
Investment treaties are designed to encourage foreign investment by providing additional safeguards to foreign investors’ commercial interests and protect them from being adversely affected by government action in the host state.
Singapore’s Chief Justice Sundaresh Menon, in his address at the International Council of Commercial Arbitration (ICCA) Congress in 2012, questioned whether it is justifiable to expose states and promote transparency and accountability, as well as protection of individual rights, when arbitrators entrusted to rule on these issues have experience in commercial law, but none on policymaking.
Justice Menon called for “a serious debate” to discuss whether the concepts of expropriation and fair and equitable treatment, which is what the treaties set out to protect in the first place, should extend as far as they now do.
“If we were all convinced that this global administrative law is fundamentally beneficial, then the next step would be to develop a rich jurisprudence to add flesh and texture to various aspects of the law. The principles of good governance, fair and equitable treatment and respect for individual investor rights need to be more clearly rationalized and articulated,” he said.