The Vodafone and India Saga: A Brutal End?
Updated: Oct 3, 2020
The mega telecom company, Vodafone has been reported to have won a long-standing battle between the Indian Government and itself. This battle stems from a bitter tax dispute that eventually ended up at the Permanent Court of Arbitration which is an international dispute resolution forum situated at Hague. The tribunal’s award is said to have gone in favour of Vodafone who are to receive a sum of approximately Rs. 20,000 crores in damages from the Indian Government. It is interesting to peek into what actually took place between the two parties and why the matter resulted in a sour dispute between the two.
Background of the decade-long dispute
The case between the two begins in 2007 when Vodafone decided to acquire two-third worth shares of an Indian telecom company, Hutchison Essar Limited (HEL) for a reported sum of Rs. 11 billion. An agreement was reached through a Cayman Island Company, CGP Ltd., who also held, 67% worth shares of the Indian Company. It is with regard to this particular acquisition that the Indian Tax authorities sought to impose a 2.2 billion worth tax amount on the telecom company for capital gains. However, Vodafone contended that such a tax amount could not be levied upon the company under the existing tax regime since no capital assets present in India were transferred between Vodafone and the Indian company.
The case was then admitted in the Bombay High Court as a result of Vodafone intending to contend the notice issued by the Tax Authorities. The Bombay High Court held that Vodafone were liable to pay the tax amount as claimed by the Indian Government. The matter was however appealed before the Apex Court of the country. The Supreme Court overturned the ruling of the High Court and held in favour of Vodafone, stating that the company could not be made liable for a tax payment by the authorities.
Amendment to the Finance Act, 2012- A Vindictive Move
The introduction of the finance bill that sought to amend Sections 9 and 12 of the Income Tax Act paved way for further feud between the parties. The matter had been put to rest after the decision of the Supreme Court until the Finance Bill was passed and made law. The interpretation of these provisions was fundamental to the decision of the Supreme Court. However, the application of the amended provisions retrospectively created a new angle through which the Indian Government could claim tax payment from Vodafone. This retrospectivity was extended till 1st April, 1962.
Section 9 played a largely important role in the decision of the Supreme Court as it determined whether or not certain incomes could be said to be earned in India even if they arise or accrue outside the country. The amendment made to the Section by approving the two explanations to the provision, clarified that companies which hold a share or interest in any company situated in India and derive interests from such a capital asset, be it directly or indirectly from such an asset, although situated outside India, shall deemed to have been a company situated in India itself. This change was also brought about retrospectively which meant that the government could claim the tax amount that had been fought off by the Vodafone prior to this amendment.
The International Dispute
Post the amendment, the Indian Government renewed their interest in claiming the tax amount from Vodafone. As a result of the same, the company decided to utilize First Investment Treaty Arbitration as laid down under the India and Netherlands Bilateral Treaty in 2012. This is a viable legal position because Vodafone invoked its Dutch unit and that made it a transaction between a Dutch firm and an Indian firm. Therefore, it would bring the transaction within the ambit of the Bilateral Investment Treaty (BIT), signed on November 6th, 1995. This BIT sought to protect investments by companies in each other’s jurisdictions and to create a favourable environment for foreign investments. The argument from the telecom agency attributed to the retrospective effect given to the amendment by the Indian Government to the Substantive Law involved.
Looking into the international dispute, Vodafone claimed that since the matter had been concluded and dealt with by the Apex body of India, the retrospective application of such a law would result in a violation of fair and equitable treatment as guaranteed under the Bilateral treaty between the two nations. Article 4.1 of the treaty also included an obligation to ensure a stable and predictable environment provided to the countries involved. Evidently, the change in law brought about a rather unpredictable environment which no prudent and reasonable person could have foreseen. The government change in 2014 saw another shift in the dynamics of the case.
Although, the new government critiqued the retrospective application of these taxation laws, however, nothing substantial was done till 2017. In 2017, however, a Second Investment Treaty Arbitration dispute was filed by Vodafone that challenged the retrospective imposition of the capital gains taxation law. Since the government had not done anything to act on their criticism of the retrospective application, they were now required to defend this retrospective imposition. In order to do this, they approached the Delhi High Court seeking an anti-arbitration injunction in the fear that two parallel arbitration proceedings could be an abuse of the process of law. However, Vodafone offered to club both the arbitral proceedings and the Delhi High Court agreeing to this offer, therefore, ruled against the Government.
The PCA at Hague ultimately ruled in favour of Vodafone and held that the government’s actions were violative of the Bilateral Treaty because it was against the tenet of fair and equitable treatment of the parties involved. The ruling also further provided that the government must pay Vodafone Rs. 40 crores as a partial 60% compensation of legal costs incurred by them, in addition to a refund of the tax collected so far.
The general rule in law is that substantive laws are to made applicable prospectively and not retrospectively as seen in the current case. Any substantive law however, if has to be given retrospectively has to be expressly mentioned by the legislature. This condition although met in the current case, would be extremely difficult to appreciate. The author submits that this general rule must be expanded to definitively include the consideration of the consequences and contradictions that would arise if retrospective application is imposed by the legislature to any existing law. This would prevent disputes like the present one and many others in future, since all these arise from contradictions. It is very important that the legislature considers the aftermath of passing a law or an amendment to a law with a retrospectively application.
Furthermore, it is pertinent to note that the Supreme Court while ruling in favour of Vodafone created an element of finality for the parties involved. The government, inter alia, in order to reverse the effect of the ruling enacted the amendment with retrospective application and this was an unpredictable change, consequently leading to an unfavourable environment for Vodafone. This unfavourable environment was undoubtedly a violation of the fair and equitable treatment promised to the party vide the Bilateral Investment Treaty.
It is the submission of the author that the lack of coordination between related ministries pertinent to the enactment of such an amendment, resulted in the loss of huge monetary sums that are finally attributable to taxpayers hard earned money. Since India has signed various Bilateral Investment Treaties and every treaty pursuant to international investment laws, has a clause citing fair and equitable treatment, that before the enactment of new rules or amendments, it is necessary that the interests of parties involved in such treaties are also taken into account. This submission is also supported by the Supreme Court when it ruled in favour of Vodafone wherein it was stated that “certainty and stability are basic foundations of any fiscal system.”
Conclusion and the Way Ahead
Although one would assume that this decade long dispute between Vodafone and the Indian government has reached its end, however, there is still a possibility that the Indian Government chooses to approach the High Court of Singapore, challenging the arbitral award. This is a viable legal option for the Indian Government since Singapore was the seat of arbitration. However, it must be kept in mind that the solution to the larger problem of contradictory BITs and enactments, is the ‘internalization’ of the process by considering clauses of BITs before enacting such retrospective amendments.
Article 3 of the UNCITRAL Model must also be kept in mind which states that the decision of the arbitral tribunal is final and the same was also invoked by the PCA when it said that the government should stop its efforts to recover capital gains tax from Vodafone now.
India is entangled in more than a dozen such cases with prominent parties like Cairn Energy and contentions primarily surrounding the retrospective application of the amendment, cancellation of contracts, etc. Such frequent breaches of investment treaties are a fallacy in the Indian legal system and must be mended. Bilateral and multilateral international obligations must therefore be kept in mind while unilaterally enacting taxation laws. India has ended more than 50 BITs with other countries in order to reduce future arbitrations. However, the Vodafone case can be considered as a symbol of India’s aggressive taxation policies and could pave the way ahead toward a liberalized investment model.
(This article is authored by Ms. Akshita Goyal, Intern at S&D Legal Associates)