By Saionton Basu | The News Minute | March 18, 2015 | 06:00 pm IST
The last week began with the news of Cairn Energy filing a notice for settlement of disputes with the Indian government under the Agreement for Promotion and Protection of Investments between UK and India. The dispute stems from a tax demand in an amount of $1.6 billion raised by the Indian Income Tax Department on Cairn Energy. The basis of the tax demand is an alleged capital gain made when Cairn Energy transferred its Indian business to a newly incorporated Indian entity in 2006 pursuant to a group re-organization. In addition, Cairn Energy has been prohibited from selling its residual stake of circa 10% in the Indian entity by the Indian Income Tax Department, whose value is said to have diminished in the period of the restriction.
At the heart of this tax demand, lies the retrospective amendments to the Indian tax code carries out in 2012 to provide for the taxation of indirect transfers of shares, post the landmark Supreme Court judgment in the Vodafone case in favour of the taxpayer. The amended law clarified that any share or interest in a foreign company will be deemed to be situated in India if its value substantially derives, directly or indirectly, from assets located in India. Accordingly, for historic cases which could be investigated under the retrospective provisions, this is a danger that will remain unless the government takes an in principle decision not to invoke these provisions. Several announcements from the current government had raised the expectations of the investor community that such cases will not be pursued. Further, in the recently laid out Budget, the term ‘substantial’ was proposed to be clarified to mean cases where the value of Indian assets: (i) exceed INR 100 million; and (ii) represent at least 50% of the value of all assets owned by the foreign company. The gains from indirect share transfers are proposed to be taxable in India on a proportionate basis i.e. to the extent the gains are reasonably attributable to assets located in India. Furthermore, the Budget statement proposed to grant exemption from taxation of capital gains arising from indirect transfers in the following scenarios:
· Foreign entity that is transferred directly owns Indian assets - Where the transferor of shares or interest in the foreign entity (along with associated enterprises) does not have the right of control and management over the foreign entity and does not hold more than 5% voting power / share capital / interest in such foreign entity.
· Foreign entity that is transferred indirectly owns Indian assets through another company - Where the transferor of shares or interest in the foreign entity (along with associated enterprises) does not have the right of control and management over the foreign entity and other company and does not hold more than 5% voting power / share capital / interest / in the foreign entity / other company.
· Transfer of shares or interest in a foreign company under a scheme of amalgamation or demerger, subject to conditions.
Given that the government of the day was going to great lengths to assuage investor concerns against what has been increasingly labelled as “tax terrorism,” the current kerfuffle with Cairn Energy has dampened investor sentiments. However, for the sake of completeness and in all fairness, it must be mentioned that the Indian Income Tax Department had commenced looking into the aforementioned transaction well before the new government took office and the current action was a belated follow through of the law taking its own course. That said, greater uniformity between the various wings of the government showing that the government speaks in one voice when it comes to tax legislation, implementation and enforcement by ceasing to act on the old files under the retrospective clause could have decisively turned the tide in favour of the new government’s posturing to garner greater foreign direct investment.
It is unlikely that Cairn Energy would have gained much, besides losing a lot more time by approaching the courts, since the 2012 retrospective legislation was in many ways overturning a Supreme Court verdict. Accordingly, the arbitration notice served on the government is a welcome window of opportunity in the six month period of negotiations provided under the treaty to arrive at a solution. Since the arbitration notice is served on the central government and not the income tax department, it is also a rare opportunity for the new government to align all agencies which have an interface with the foreign investor community towards its avowed objective of providing a stable and predictable tax administration.
The need of the hour is for the government to decisively and quickly put this issue to bed, since any vacillation, after all the tall utterances domestically and internationally, will put all other initiatives to test on the touchstone of matching action with words.
Saionton Basu is a London-based lawyer.
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