Vodafone Arbitration Award: Opportunity To Enhance India’s Investment Credibility

May 28, 2012, was a day that cast a long and dark shadow on India’s credibility as a foreign direct investment destination. It was the day the Congress-led UPA government passed a retrospective amendment to the Income Tax Act, 1961 to tax “indirect transfers”, effectively nullifying the judgment of the Supreme Court dated Jan. 20, 2012, in the case of Vodafone International Holdings B.V. Vs Union of India.

The Supreme Court had held that a transaction undertaken in respect of a Cayman Island entity was not liable to capital gains tax in India as Section 9 did not have a “look through” provision. Consequently, there was no authority in law to tax “indirect transfers” of a “capital asset” situated outside India.

The retrospective amendment was made by the insertion of Explanation 5 in Section 9 of the Act. Explanation 5 legislated that transfer of shares or interest of an entity outside India, which draws its value substantially from assets located in India, “shall always be deemed to have been situated in India”.

The retrospective amendment created an uproar among India-focused investors and the tax community world over. And while FDI flows have recovered over time, India’s international standing as an investment destination remains hurt by this move.

The Indian Judicial View On Retrospective Amendments

When faced with the 2012 retrospective change in tax law, Vodafone chose not to challenge it.

Over time the Supreme Court has had occasion to examine the legality and constitutionality of retrospective amendments. In its landmark 1996 judgment in the case of Indian Aluminium Co. v. State of Kerala, it was declared as settled law that legislature can, by enacting a valid law on a topic within its legislative field, always render a judicial decision ineffective by fundamentally altering or changing its character retrospectively.

Since then a variant view in relation to retrospective amendments, in different facts and circumstances, has been taken. In the 2014 case of Vatika Township, the Supreme Court emphasised on the doctrine of fairness and observed that law passed today cannot apply to the events of the past.

At the time though, in view of the likelihood that a challenge to the subject retrospective amendment might not succeed given the Indian Aluminium line of judgments, it appears that the Senior Counsel for Vodafone explored a more innovative option -- to test the legality of the retrospective amendment under the India-Netherlands and the India-U.K. Bilateral Investment Treaties.

BIT Proceedings And Tribunal Award

A series of proceedings and dialogues, ultimately culminated in Vodafone filing an international arbitration under the BIT. An Arbitration Award was passed by the international tribunal on Sept. 25, 2020. The award was unanimously passed by all the three members of the tribunal. The operative part of the Award holds that:

1. The Arbitral Tribunal had the jurisdiction to deal with the present issues under the BIT. This appears to be in response to India’s submission on jurisdiction, to the effect that, tax disputes were excluded under the relevant BIT.
2. Under Article 4 of the BIT, Vodafone was entitled to “fair and equitable treatment” (FET) in respect of its investments in India, which was denied to it. The Indian government’s conduct in respect of the imposition of tax, interest, and penalties, undertaken specifically despite the Supreme Court judgment in Vodafone’s case, is in breach of the BIT.
3. India should “cease the conduct in question” and any failure to comply with the directive will “engage its international responsibility”.
4. India must pay a percentage of legal costs and fees totaling to £4.32 million.

The exact reasoning and the analytical basis of the tribunal’s award will only be known, if and when, the award is made public. As things stand today the key consequence of the award is that the Indian government can no longer demand tax ($3 billion) on the Vodafone transaction.

The Government of India has indicated that it is examining its appeal options either in Singapore (where the seat of arbitration was) or in Hague (where the International Court is situated).

Yet, it will be important to understand whether this tribunal decision can offer hope to other similar cases.

What Does This Mean For Similar Cases

From the operative part of the award, it is unclear, whether the award deals with the ‘fair and equitable treatment’ issue only in the context of Vodafone’s facts, given that the relevant Supreme Court judgment which was nullified by the retrospective amendment was a judgment in Vodafone’s case. If so, this would raise an issue as to whether the same conclusion would be reached for an entity, other than Vodafone.

It is currently unclear whether there are any generic findings, that the retrospective amendment per se breaches the FET clause on pure legal principles under the BIT. The answer to this issue, will most likely emerge in the case of Cairn/Vedanta, the tribunal award in which is expected shortly.

It is also of some interest, as to how the tribunal directions for India to “cease the conduct” will play out. One view is that any conduct by India to seek to enforce the tax demand despite the award or failure to make the payments directed, would invite action for acting contrary to “cease the conduct” direction.

There are a series of BIT arbitration proceedings, where the actions of the Government of India have been challenged, in relation to the retrospective amendment of May 2012, and in relation to a series of other issues, including the cancellation of various licenses in the satellite and telecom sectors. In many of these proceedings, India may have a substantial liability for payments running into billions of dollars.

Redemption Opportunity

When the BJP government first came to power in 2014, the then Finance Minister very clearly signaled in the union budget of 2014, that the new government does not support retrospective amendments, which create fresh liability for assessees. The BJP government also indicated that it was defending this BIT and other legal proceedings related to the Vodafone retrospective amendment, as it was duty-bound to defend the actions of the previous government, although the BJP government was not supportive of such retrospective amendment.

Given India’s renewed efforts to enthuse fresh FDI into India, in the aftermath of the anti-China post-Covid sentiment, it is critical that the government curates its response to the arbitral award, not as a purely legal issue, but as a heaven-sent opportunity, to signal its pro-investment stance to the international investor community.

It would be even worse for India to challenge the award, while in the parallel, engaging with foreign investors, to assure them of India’s credibility as an investment destination.

India’s actions would speak louder than its words.

Post the award, it would be fitting for this government—having done its utmost to defend an “indefensible provision”—to distance itself from the actions of the previous government and to accept the award.

This would exhibit the statesmanship of the present government and signal very strongly India’s commitment to fairness and equity, in dealing with investing partners.

We must not mistake the ongoing FDI, as having obliterated the adverse impact of this retrospective amendment. This award presents India with a unique opportunity, to enhance its credibility and standing, an opportunity which India must not miss.

Rohan Shah is Counsel at the Supreme Court and Bombay High Court.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.