Retro Tax Gone – Review Of Model Bilateral Investment Treaty Should Be Next
Aug. 5, 2021 will go down in Indian tax history as the day retro became a thing of the past. On that day Finance Minister Nirmala Sitharaman presented the Taxation Laws (Amendment) Bill, 2021 in Parliament. With that one move she finally salvaged India's 'tax terrorism' reputation and put an end to an internationally criticised retrospective provision of taxing capital gains realised by a nonresident from sale of share or interest in a foreign entity which derived substantial value from an Indian asset.
Much has already been discussed on what the provision was and what happens next with the pending 17 cases.
So this article focuses on the lesser discussed victim of retro tax - bilateral investment treaties.
This provision, introduced in 2012, resulted in two high profile international arbitration losses - in the cases pursued by Vodafone and Cairn.
To be clear, the international tribunal awards have not at all penalised India for its tax provisions. The awards have only found India in breach of its commitment under the relevant treaties, of according fair and equitable treatment to entities which invested in India. The fact that this treatment was found to have resulted from retrospective tax is a coincidence.
Hence, it is important to appreciate that the arbitral tribunals did not rule on India’s ability to exercise its sovereign right to enact laws domestically, whether in respect of taxation or otherwise.
Yet, pursuant to the arbitration notices, on account of the retro tax as well as cancellation of 2G telecom licenses by the Supreme Court, India got cold feet regarding the bilateral investment treaties it had signed over decades and terminated 77 BITs between 2017 and 2021.
Thus, despite a government change, not only had India not removed tax uncertainty borne of the retro tax, it then subsequently withdrew BIT protection to foreign investors, and introduced a model treaty which restricts the rights of investors to seek protection significantly.
It was baffling. The move hurt fresh foreign investment the most. Because, interestingly, the terminated treaties have a survival clause in Article 15 clause (2) which ensures the applicability of the BIT for the next 15 years (in most cases) for investments made or acquired before the date of termination. Hence, termination would not achieve the objective of non-invocation of BIT if the investment was made prior to the date of termination. And the risk of invocation remains for the survival period post termination.
It's new investment that would be denied treaty protection. That's the message India was sending the world. Even as it ignored that BITs work both ways. Indian multinational companies seek similar protection in countries they invest in.
Sovereign Right Can Coexist With Investor Protection
The main reason forwarded by the government for the mass termination of treaties was that they were one-sided as regards recognising the sovereign right of India to formulate its laws, especially taxation laws.
This issue has been debated at length by legal experts in India and elsewhere. When a sovereign nation decides to have bilateral relationship on trade and commerce, it acknowledges and accepts certain rights that it provides to the residents of the other nation. To that extent, the parties entering such relationship acknowledge dilution of their sovereign rights to give comfort to investors that exercising the sovereign right will not jeopardise the investor’s investment in India.
Additionally, any bilateral treaty is governed by the customary law on treaties enshrined in the Vienna Convention on the Law of Treaties. This applies to all bilateral treaties regardless of whether the particular jurisdiction is a signatory of the VCLT or not. Thus, once India entered bilateral treaties — whether taxation or BIT — India is bound by the customary law enshrined in VCLT and must give effect to the treaty provisions in good faith and not use its domestic law to argue inability to honour treaty provisions.
In the past several years, though India has continued to attract significant foreign investment, it can hardly be claimed that the quantum needed for a major boost to the economy, through creation of state-of-the-art infrastructure, has found its way here.
The importance and relevance of infrastructure funding for the development and exponential growth of economy can hardly be over-emphasised. And though India improved its ranking on the Ease Of Doing Business index, a surge in inflow of foreign direct investment for massive infrastructure spending has remained elusive.
As advisers on foreign investment, many of us have faced significant apprehension from investors. They look for protection contractually by seeking indemnity and/or taking insurance. Clearly, the risk of both these on the investee projects can be prohibitively huge if there were retrospective changes in tax laws or sudden policy turnarounds as witnessed on account of the Supreme Court’s cancellation 2G telecom licenses sans BIT protection.
The way to overcome this FDI nervousness is to ensure Indian BITs protect capital invested by foreign investors and thus reciprocally ensure protection of capital invested by Indian multinationals abroad. While India should retain the right to change its laws, certainty of no adverse impact can be provided by a simple clause -- that once investment is made in satisfaction of the applicable conditions, no subsequent change in law would jeopardise the investment. The only exception maybe in the case of proven fraud.
Another provision can be that in case of any ambiguity with regard to inbound investment, a clarification granted by the appropriate governmental authority will remain final, even if it is subsequently found that an error was committed, unless the clarification was obtained through fraudulent means. 'Fraud' and 'fraudulent means' should also be clearly defined.
There are instances of BITs providing such protection – such as the Canada-China BIT. On the other hand, India's model BIT is far more protective of government action and drafted to overcome any and all claims of protection against most measures that Indian government may take. Even the definition of 'expropriation' is very stringent. Besides, there is no reference to International Centre for Settlement of Investment Disputes, though arbitration is envisaged in the most extreme situation. It is almost as if no Indian business enterprise is going to need such protection in the other jurisdiction.
On Monday, the Finance Minister announced the roadmap of an ambitious Rs 6 lakh crore national asset monetisation pipeline. Its success will depend on the participation of foreign investors. While the repeal of retrospective tax law is a huge step in the right direction, very serious all-round consideration must be given to all the factors relevant for huge capital inflows in to the country, including investment protection to such investors.
Daksha Baxi is an international tax advisor, and founder at SRI Solutions.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.