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Will the curtains fall?

20 Jun 2013
The controversial $2-billion dispute between Vodafone BV, a company incorporated in the Netherlands, and the Government of India traces back to 2007.

The dispute stems from a transaction involving a purchase by Vodafone of one share of CGP Investments Holdings Ltd, a Cayman Islands company, from Hutchison Telecom International Ltd, a Cayman Islands entity owned by the Hutchison group. The Indian revenue authorities contended that, as the transaction resulted in an indirect transfer of business assets located in India (ie controlling interest in an Indian operating company) from Hutchison to Vodafone, Vodafone was liable to withhold taxes on such payments to Hutchison. Vodafone successfully challenged the levy of capital gains tax before the Supreme Court of India, which ruled that the sale of shares having situs outside India by a foreign company to another foreign company could not be brought within the scope of taxation in India since the law provided for levy of capital gains tax on direct transfer of shares. Thereafter, with an intention to overrule the January 2012 judgment, the Government via the Finance Act 2012, made several amendments to the income tax laws, with retrospective effect, specifically bringing to tax such indirect transfer of shares.

The retrospective amendments drew strong criticism from foreign investors in particular on certainty and stability of our tax regime. To assuage investor sentiments, the Prime Minister was constrained to set up an expert committee under Parthasarathi Shome. The expert panel’s primary recommendation was that the provisions relating to taxation of indirect transfers should be applied prospectively. It further recommended that where tax demand is raised due to retrospective amendment, neither any interest nor penalty should be levied.

Having won a long-drawn legal battle at the highest court and in circumstances where a review against the said judgment of the Supreme Court was also dismissed, a retrospective amendment nullifying the effect of the judgment, in Vodafone’s view, meant expropriation of bona fide investments in the telecom sector. It is Vodafone’s case that such change amounted to denial of justice and breach of the Government’s obligations under the India-Netherlands bilateral investment treaty (BIT) to accord fair and equitable treatment to investors. On 17 April 2012, Vodafone invoked the dispute settlement process under BIT. Article 9 of BIT details the manner in which disputes can be resolved between the contracting parties. BIT provides for a 3-month period of negotiations for amicable settlement of the dispute after which conciliation may be resorted to, if both parties so agree. Since the 3-month window expired Vodafone initiated conciliation with the Government of India under BIT, which follows the United Nations Commission on International Trade Law (UNCITRAL) rules.

The Government rejected Vodafone’s offer for conciliation under UNCITRAL and instead, on the recommendations of the Attorney General, made a counter-offer for a non-binding conciliation under Indian laws, ie Part III of the Arbitration and Conciliation Act 1996, which is based on UNCITRAL. The recent Cabinet nod for settlement, although under Indian laws and not under UNCITRAL, as offered by Vodafone appears as a positive step. However since the conciliation shall be non-binding on both parties it is unclear whether the conciliation offer would result in effective resolution of the dispute.

Equally important is to understand that by virtue of the retrospective amendments the original demand notice (served on Vodafone) has been revalidated and therefore the only way to settle is through a mechanism provided under the Income Tax Act 1961. Accordingly, the disputed tax demand can either be settled through adjudication (which will obviously be against Vodafone as the law has been amended retrospectively) or through a settlement under the statutory provisions pertaining to Settlement Commission (which Vodafone is not eligible for). An alternate legal recourse for Vodafone is to challenge the constitutionality of retrospective amendments, a path that Vodafone chose not to walk. Further, whether or not the conciliation can be done under Part III needs to be examined as it is a taxation matter which under normal course is not susceptible to conciliation unlike other jurisdictions which allow for settlement of tax disputes through arbitration and conciliation. India’s existing framework for conciliation only provides for conciliation of disputes which arise out of a legal relationship, and such legal relationship may be contractual or otherwise. It is also unclear whether any legal relationship exists between an assessee (ie Vodafone) and the sovereign (ie the Indian Government) in absence of a contractual relationship. Therefore, to enable conciliation, there seems to be a need to amend both the IT Act and the Arbitration and Conciliation Act 1996.

By making the counter offer, te Government has set the ball rolling and now it is for Vodafone to weigh pros and cons before accepting or rejecting the counter offer so made. In the event Vodafone accepts the offer, the Government will proceed with the matter and 2 conciliators will be appointed to suggest an outcome, one on behalf of the Indian Government to be appointed by the Prime Minister and Finance Minister and another conciliator by Vodafone. Thereafter, if both parties agree to an outcome suggested by the conciliators, a draft settlement will be submitted to the Cabinet for its approval and appropriate amendments would be made to the IT Act to facilitate settlement. The demand of tax, interest and penalty shall be kept in abeyance until conciliation proceedings conclude.

Your Taxand contact for further queries is:
Mukesh Butani
T. +91 124 339 5010

Also published in the Financial Express, 19 June 2013

Taxand's Take

There are 2 possible outcomes of such conciliation process under Indian laws, if agreed to by Vodafone. In a situation where Vodafone and the Indian Government are able to arrive at a settlement during the conciliation process, the same would be formalised by way of a written settlement agreement. Such an agreement would be final and binding on both parties and shall have the same status and effect as if it was an arbitral award. An important difference that emerges is that, unlike Part III, the settlement agreement under UNCITRAL does not have the same status and effect as an arbitral award. However if Vodafone and the Government are unable to reach a settlement, it seems Vodafone would have an option of going back to Article 9 of BIT to invoke arbitration proceedings under UNCITRAL.

In the event Vodafone declines conciliation the Government has offered another counter offer under common law. This would mean that the entire process would be more open-ended and flexible and would be based on broadly-accepted judicial principles on international taxation. Under such framework, if the common law process does not yield a satisfactory outcome, both parties will have freedom to explore other options.

In summary, there seems to be continuing delay on this long-drawn battle and its ultimate resolution.

Taxand's Take Author

Mukesh Butani
Taxand Board member