By Upasna Agrawal
Recently, the decision of the Permanent Court of Arbitration at Hague has raised many questions on the way laws are enacted in India. The Permanent Court of Arbitration pulled up the Indian authorities for violating their treaty obligations under the BIT (Bilateral Investment Treaty), 1955. The violation of fair and equitable treatment under the treaty was the main contention. If Indian authorities had continued to undermine the decision of the judiciary and enact retrospective laws, it would have created a hostile environment for business in India.
Where it all started:
Vodafone International Holding (VIH), Netherlands and Hutchison Telecommunication International Limited (HTIL), Hong-Kong are two non-resident (of India) companies for purpose of taxation. These companies entered into transaction by which HTIL transferred the share capital of its subsidiary company based in Cayman Island i.e. CGP international or CGP to VIH. VIH bid to acquire HTIUs equity interests in Hutch Essar Limited (HEL) to enter the Indian Telecommunications Industry. HTIL transferred its equity interests in HEL by selling the single share of CGP to VIH. The parties acknowledged that the consideration received by Hutchison for the sale of the CGP share was ascertained on the basis of 67% of the economic value of HEL. The Income Tax Department of India was of the view that the Hutchison gains were chargeable to tax under Indian taxation laws. Following the exit of Hutchison from India telecommunication market, a notice to VIH by the Income Tax Department for not deducting tax at source as required under the Income Tax Act of 1961. Vodafone argued that the law in India required to tax only when the gains arose from the transfer of capital assets that are situated in India. However, in the present case, Hutchison’s gain arose from the sale of shares of CGP, which was located in the Cayman Islands. Thus, the gains were not taxable in India and there was no violation of Indian laws.
In 2010, the dispute came before the Bombay High Court. The main issue was the chargeability of Hutchison gains in India, i.e., the Court had to decide whether Hutchison gains arose from a capital asset situated in India and were taxable under Indian laws. The Bombay High Court came to the conclusion that the business understanding of the parties was to transfer the controlling interest in VEL (Indian JV Co.) which had significant nexus with India. It was held that while transfer of a share of CGP per se could not be taxed in India due to lack of situs in India, intrinsic to the transaction were transfer of other rights and entitlements – such ‘bundle of rights’ also constituted ‘capital assets’. Section 195 of the Income Tax, 1961 which provides for a tax withholding obligation would arise including on a non-resident once the nexus with India was shown to exist in the present case.
The Supreme Court came to the conclusion that the transaction was a bonafide FDI transaction and did not invoke the provisions of the Income Tax Act, 1961. The Court further relied on the fact that Hutchinson has the intention to exit the Indian market. This decision did not go well with the Indian government and the tax authorities.
What was the fuss about in the Permanent Court of Arbitration?
After the Supreme Court ruling in favor of Vodafone, the government hastily enacted amendments in the tax laws of India retrospectively, giving them effect from 1961. The amendments were made to the laws on which the Court had based its reasoning in the judgment. Once the amendment was enacted, the Income Tax authorities pursued Vodafone for their tax liabilities. At this juncture, VIH decided to invoke the Bilateral Investment Treaty which was signed between India and Netherlands. The main argument before the Permanent Court of Arbitration (PAC) was that of the violation of fair and equitable treatment: once the Supreme Court had decided the matter, the Indian authorities were wrong in enacting a retrospective law. Circumventing the decision of the Apex Court would bring unpredictability to the business environment in the country, thereby violating the treaty obligation.
PAC ruled in favour of VIH and held the Indian authorities accountable for violating their treaty obligations. The Court also levied a fine on the Indian authorities as a compensation to VIH for the cost of litigation and arbitration. Further, in the case before the PAC, Indian authorities can be said to be doing forum shopping by moving the arbitration from Netherlands to London. As of now, there have been reports circulating in the media about the Indian government considering its options against the decision of PAC.
Indian authorities too enthusiastic about applying laws retrospectively
A retrospective law enacted can severely affect the rights of the parties. As in the present case, the law clearly did not exist to entail any liability upon Vodafone. However, pursuant to the decision of the Supreme Court which was against the Income tax authorities, the laws were hastily amended in a manner to benefit the Indian authorities and to the detriment of Vodafone. Had the laws been enacted before the Supreme Court judgment was pronounced, they might not have been questioned. But the timing of the amendments being brought in force made the case a legend in tax laws.
The Indian government has always notoriously changed laws after the decision by the judiciary, if they are not in their favor. Indira Gandhi v. Raj Narain is a classic example of how the executive felt threatened by the decision of the judiciary and decided to change the laws by enforcing emergency in the country. Although the impact of the amendment after the Vodafone case is different, it is comparable. Changing laws retrospectively, especially tax laws, can create uncertainty in the business world. It will deter companies from entering the Indian markets. Indian authorities should aim at creating a more favorable environment for investors. At this time, when India is in grave need of foreign investment to revive the economy of the country, it is essential that the Indian legislature acts in a prudent manner while making amendments and enacting new laws.
Curious case of multiple litigation between Indian tax authorities and Vodafone
It seems like Indian tax authorities have a lot to recover from Vodafone, however, they refuse to pay the company its dues. In a recent decision, the Supreme Court dismissed a special leave petition filed by the Income Tax authorities against the order of the Bombay High Court which directed the authorities to pay 833 crore INR to Vodafone. The money was due to Vodafone as a part of its income tax returns for the year 2014-15. It is now to see if the government authorities will stop going after the cash-strapped telecommunication company and pay them back what they deserve as per law.
About the Author:
Upasna is a B.A. L.L.B.(Hons.) graduate from Jindal Global Law School.