NDTV | 29 May 2021
The Cairn $1.4 billion award is patently illegal
by Ashish Khetan
In this piece, I attempt to lay bare the patent illegality of the Cairn arbitral award to enforce which it has brought a lawsuit in the US against national carrier Air India.
One of the arbitrators involved with the $1.4 billion award for Cairn - Stanimir A. Alexandrov - has been recently censured for not disclosing his conflict of commercial and business interest in another international arbitration that he presided over. In 2017, Alexandrov awarded a multinational corporation €128 million in award against Spain. In an appeal, Spain has successfully demonstrated that the undisclosed business relationship between Alexandrov (who was appointed as an arbitrator by the foreign corporation in question) and the corporation’s associate parties had been ’improper’. As a result, in July 2020, a judicial committee annulled the award against Spain.
Even before this controversy, Alexandrov’s conduct had been under intense scrutiny. He has a history of being appointed by the same disputing-party type, a practice which makes him a ’repeat arbitrator’, raising serious questions about his independence. In the Cairn Energy v India dispute too, Alexandrov was appointed by the corporate as an arbitrator.
But there are other strong grounds that make the Cairn arbitral award legally suspect.
Firstly, the arbitral award has condoned the tax avoidance scheme adopted by Cairn Energy. In paragraph 1040 of the award, the tribunal acknowledged that Cairn made a capital gain of at least 5.5 billion dollars in 2006. Then, in the very next para, the tribunal records Cairn’s claim that "those gains were in principle taxable in the UK", where it is domiciled, but it "did not pay tax in the UK either."
Cairn achieved the contemptible end result of double non-taxation by holding its Indian assets through an indirect corporate shareholding structure layered across many jurisdictions, including tax havens like British Virgin Islands and Jersey.
Indirect holding of assets is an egregious technique developed and widely used by multinationals to avoid the payment of Capital Gains Tax (CGT) in a country where the assets are actually located. In layman’s terms, you transfer the ownership of your house located in Mumbai or Delhi to a shell entity incorporated in Jersey or Cayman Islands or in some other tax haven. When you sell your house, you transfer the shareholding of your shell entity to a similar post box company of the new owner in the same or another tax haven. And you are not liable for capital gains tax in India. But hang on, you are a common man. If you are a multinational corporation and own India’s natural assets like mines, oil and gas fields and telephone spectrum, and your capital gains taxes run into tens of thousands of crores, you resort to Offshore Indirect Transfer (OIT) which involves complex corporate structures and the establishment of intermediary entities in tax havens. Cairn, Vodafone and Hutchinson have all avoided paying CGT in this fashion. (OIT is only part of an overall trend of corporate tax avoidance. But that’s a discussion for another day).
In 2015, the United Nations Conference on Trade and Development (UNCTAD) estimated that developing countries lost around $100 billion per year in revenues due to tax avoidance by multinational enterprises, and as much as $300 billion in total lost development finance. Oxfam and Finance Uncovered documented in a 2020 report seven cases of CGT avoidance through OIT, which have resulted in a total loss in tax revenue over $2.2 billion to poor countries such as India, Uganda and Vietnam. Yet, the tribunal in para 1813 of the award concludes that India "has failed to prove a case of systemic abuse (of indirect holdings) by foreign investors."
After the 2012 tax amendment (which some in business media and the corporate world deride as ’retrospective taxation’), there was little doubt that Offshore Indirect Transfers were subject to taxation in India because if similar transactions had been entered into by Tata, Reliance or Adani (which are Indian corporate houses), they would have been liable to pay capital gains tax. Even without the 2012 amendment, the 2006 transactions would have been taxable because (i) they were tax avoidant transactions, and thus taxable under the "look at" doctrine developed by Indian courts, which focuses on substance over form, and (ii) they entailed the indirect transfer of immovable property, which is taxable under Section 2(47)(vi) of the ITA.
The income tax department calculated Cairn had made a capital gain of US$ 5.5 billion when it restructured its business in 2006 and raised a tax demand of capital gains tax of US$ 1.6 billion, plus applicable interest and penalties. This was upheld in 2017 by the Income Tax Appellate Tribunal. Instead of fighting it out by filing an appeal in Indian domestic courts, or challenging the constitutionality of the 2012 amendment before the Supreme Court of India, Cairn rushed to take shelter in the India-UK Bilateral Investment Treaty. The purpose of that treaty was that UK investors like Cairn and Vodafone should not be treated unfairly as compared to Indian domestic investors like Tata, Birla or Reliance. It was never meant to allow UK investors to dodge paying their taxes in India or be treated more favourably than Indian domestic investors.
What makes the Cairn arbitral award egregiously illegal is that three private corporate counsels acting as arbitrators in the tax dispute between Cairn and India not only substituted themselves for the entire Indian judicial system and ruled that India cannot tax Cairn, but they also condoned its aggressive tax avoidance scheme. The award concludes: "the fact that the Claimants (Cairn) and other foreign investors who indirectly owned assets in India through a series of subsidiaries should engage in indirect transfers without paying tax cannot be characterised as abusive, or the exploitation of a loophole." At other places, the tribunal has conceded it is not "a tax assessment court", but it nevertheless tested the validity and applicability of Indian tax laws, ruling in favour of Cairn.
Secondly, retrospective tax legislation is a legitimate exercise of sovereign power. "If there was a power to impose taxation conferred by a constitution, the legislature could equally make the law retroactive and impose the duties from a date earlier than that from which it was imposed" (SC decision in Chhotabhai Jethabhai Patel v. Union of India). The Indian parliament has introduced as many as 346 retrospective amendments to the Income Tax Act 1961 since its enactment. Whether the 2012 amendment was ’retrospective’ or ’clarificatory’ can only be resolved under Indian law. But even if it is ’retrospective’, it is still a valid law. It is a well-settled legal provision that parliament has the sovereign power to tax either prospectively or retrospectively, even when it renders previous court judgments ineffective. By asking India to forego its tax revenue, the tribunal has infringed upon the sovereignty of Indian parliament and its people.
(Ashish Khetan is an author, lawyer, and columnist.)