Vodafone vs India: Who ‘Committed’ the ‘Original Sin’?

In the sorry saga of the Vodafone tax dispute, how did we get here? The original error lies with our tax laws.

‘Biblical’ ‘Forbidden Fruit’ referential image, and Vodafone logo used for representational purposes.

(Photo: Altered by Shruti Mathur / The Quint)

The sorry saga of the Vodafone tax dispute, and its torturous legal route, seem destined to expose more than one fault line in the ‘rule of law’. Vodafone, in the arbitration under the Netherlands-India Bilateral Investment Treaty (BIT), terminated by India in 2016, has secured a comprehensive victory – injunctive as well as monetary relief.

The retrospective tax amendment passed by the Indian Government in 2012, deeming overseas share transfers as share transfers in India, was held to be contrary to the fair and equitable clause of the BIT, and the Government of India was asked to cease its conduct in seeking to recoup its tax liabilities under the amendment. Further, GBP 330,294.50 in legal fees and costs were awarded, and a refund of the amount already seized.

We have the rather unseemly sight of an arbitral tribunal restraining the Indian tax authorities from acting on its demand for dues. 

The award, passed in the Hague, is of course appealable, but also executable using the long arm of the Dutch court’s jurisdiction. The question now is – how did we get here?

How the Govt of the Day Compounded the Problem

The original error lies with the tax laws. A convoluted, but consistent with international practices, transaction that involved a Cayman Island transfer of shares was held to be beyond the reach of the Indian Income Tax for purposes of deposit of Tax Deposited at Source (TDS), with the seller being outside of the Indian jurisdiction. While one can quibble with the Supreme Court holding that the transaction – with its complex layering of ownership spanning multiple jurisdictions – was a bonafide structured FDI sale, domestic taxation law was inadequate and in many ways, still is – in dealing with sale of shares of companies which had assets in India.

Instead of moving on, the government of the day compounded the problem by introducing a deeming provision in the Finance Act of 2012 whereby, in the nature of a clarification – ‘for the removal of doubts’, the underlying asset deemed the transaction to be one in the Indian jurisdiction, and hence subject to Indian tax jurisdiction.

Further, they made this deeming provision absurdly retrospective to 1961. Logically, and rightfully, the Indian courts should have struck down at least the retrospectiveness of the deeming provision as unconstitutional for being, if nothing else, entirely arbitrary and unreasonable, as all retrospective taxation decisions are, particularly when they claim to be nothing more than clarifications on what the legislation did not mean to do in the first place.

For the Act to assert that this was the original intent was an absurdity, and laughable if not for its consequences. Retrospective tax legislations make planning for taxation impossible. As the Damodar Committee opined, death and taxation are inevitable, but death “is never retrospective”.

• Vodafone, in the arbitration under the Netherlands-India Bilateral Investment Treaty (BIT), terminated by India in 2016, has secured a comprehensive victory – injunctive as well as monetary relief.
• The award, passed in the Hague, is of course appealable, but also executable using the long arm of the Dutch court’s jurisdiction. The question now is – how did we get here?
• The original error lies with the tax laws.
• Vodafone, through various subsidiaries moved, first, under the Indian Dutch BIT, and then, as a fail safe, under the Indian UK BIT. The latter is still pending.
• The retrospective tax legislation, whatever be the merits of taxing transactions of Indian assets done in tax havens, is fundamentally bad policy.

‘Problematic Means’: ‘Elevating’ the Status of the Private Investor

Vodafone, through various subsidiaries moved, first, under the Indian Dutch BIT, and then, as a fail safe, under the Indian UK BIT. The latter is still pending. The retrospective tax legislation, whatever be the merits of taxing transactions of Indian assets done in tax havens, is fundamentally bad policy.

Vodafone would have been correctly advised to pay Hutchison the sale price without withholding tax, and it can scarcely be asked to go back in time by a retrospective amendment.

The means, however, remain problematic.

India has rightly terminated most BITs, including the Dutch India one, as they are caricatures of both international law and domestic laws. They seek to elevate the rights of shareholders in limited companies, who are shielded from liability based on the domestic law of their incorporation – a practice recognised from a decision of the International Court of Justice in the Barcelona Traction case – to rights in public international law. BITs not only expand these rights to rights in public international law, but bestow upon shareholders – even upstream ones – as is the case here, with remedies in quasi public international institutions.

This is a remedy not bestowed upon any other individual or group of individuals in public international law – enforceable through the powerful mechanism of commercial arbitration. It lifts the status of the private investor to the pedestal of a foreign state.

Why Vodafone Netherlands Isn’t Liable For Actions of Vodafone India – But Can Claim Damages

Legal gymnastics do not deter from the Frankenstein nature of the BIT monster – all designed to ensure that in times of decolonisation and nationalisation of foreign assets, foreign investments would be protected from expropriation.

It is an extension of the principle of ‘diplomatic protection’ offered by countries to their investors, which is a polite term for the gunboat diplomacy which used to be practised by western countries to protect investments. In the hands of commercial arbitrators, it has gone much further, ruling on policy decisions such as the Argentinian currency reforms, and offering rights in international law simply not available to any other class of investor, person, or company.

To put it in perspective, Vodafone’s Netherlands company is not liable in any court for the actions of Vodafone India, but can claim damages for the harm done to Vodafone India.

Why the Pushback Against Bilateral Investment Treaties (BITs)?

India has not faced the brunt of BIT as much as other nations. However, in a notorious case, White Industries was awarded USD 4 million because of the failure of Indian courts to enforce an award in its favour for a decade. BITs have increasingly been used to arbitrate economic and monetary policy of countries, a practice derided by the Delhi High Court in 2017 even as it declined to issue an injunction against Vodafone for filing the UK claim. The Delhi High Court did hold that Indian courts have jurisdiction to entertain actions against BITs if they were oppressive, inequitable, or constitute an abuse of the legal power.

India has sought to recast its bilateral investment treaties, terminating most of them in 2016.

However, India’s model BIT treaty – more weighed in favour of India, and excluding the fair and equitable clause and tax provisions from BIT purview, and requiring exhaustion of domestic remedies – has not been accepted by most other countries. This is a sticking point in the Free Trade Agreement being negotiated with the European Union.

The pushback against BITs is, however, not limited to India. They have been recognised to be systematically in favour of the investor.

Indian Tax & Economic Policies Need to be Fairer and More Equitable

There is little causation to whether they promote economic development. The European Court of Justice recently ruled that BIT between European countries was contrary to European treaties, as they ousted the jurisdiction of courts.

India’s strategy has been to seek, so far unsuccessfully, to negotiate new BITs, and for existing awards, not comply with their outcomes. It has thus far not paid the amounts due to Deutsche Telekom and Antrix Corporation Ltd. A Nissan BIT dispute under the Indo-Japan CEPA is pending in Singapore.

None of this, however, deviates from the fact that Indian tax and economic policies need to be fairer and more equitable, to all classes of investors, domestic and foreign.

And when absurdities such as the 2012 retrospective amendment is brought in – parliament or the courts should put a stop to it. Unfortunately, for now, this seems to be wishful thinking.

(Avi Singh is an advocate who specialises in transnational law and serves as the Additional Standing Counsel for the government of NCT of Delhi. He tweets @avisinghesq. This is an opinion piece and the views expressed are the author’s own. The Quint neither endorses nor is responsible for them.)