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Continuation of Vodafone Case Sparks Treaty Reviews
In January 2012, Vodafone won a five-year legal battle when India's Supreme Court ruled that it had no liability to account for withholding taxes of approximately $2.5 billion. Whilst this case had appeared to close, and also set a key precedent for the international tax arena - for victory for foreign investment - it is now developing into further international arbitration. Taxand USA explores the case and whether the current stance of US tax authorities on arbitration is appropriate.
When the Supreme Court judgment was entered on the Vodafone case, tax advisors worldwide commented on its magnitude for international investment and credited the Indian Supreme Court for reaffirming the rule of law. However, displeased with the outcome, the Indian legislature struck back with a retroactive (back to 1962) tax legislation proposal in the Indian Finance Bill 2012. This proposal effectively overturns the Indian Supreme Court's verdict. Vodafone International Holdings BV subsequently served the Indian government with a Notice of Dispute on 17 April 2012 - the first step required prior to the commencement of international arbitration under the bilateral investment treaty.
Although the initial issues in the Vodafone case revolved around the imposition of a withholding tax, the focus of the controversy has shifted to whether tax laws that affect international transactions can be amended retroactively by the respective domestic government. While we have yet to see the final impact that Vodafone will have on international investment and taxation, it reflects the growing trend to settle international disputes via arbitration. Although arbitration has been around for quite some time, its application to international tax transactions is still in its infancy.
Many of the US current income tax treaties in force do not even contain arbitration provisions. Rather, when a US taxpayer becomes concerned about the implementation of a treaty, the matter is tackled by the US competent authority, who will seek to resolve the matter with the treaty partner's competent authority. The competent authorities are expected to work cooperatively to resolve disputes as to the appropriate application of the treaty.
However, as the number and complexity of cross-border tax disputes continues to rise with globalization, the number of instances where competent authorities will not be able to reach a timely and satisfactory resolution is also expected to rise. Therefore, the U.S. Treasury has increasingly moved towards adding arbitration into the mix - first by exploring voluntary arbitration and now with moving towards mandatory arbitration.
Taxand US discusses the Vodafone case and its impact on international treaties
The Treasury is discussing the possible inclusion of an arbitration provision with a number of our other key income tax treaty partners. Accordingly, we may expect to see similar provisions instituted and tested in the future for resolving international tax matters.
As neither these provisions nor U.S. income tax treaties in general address retroactive changes in foreign or domestic law, we should take notice of the Vodafone case and its continued complications: international tax disputes may fall outside remedies provided in our various income tax treaties. We must continue to be cognizant of the domestic laws where our clients wish to invest and keep mindful that the implications of such investments may ultimately turn on non-tax-related matters (such as the ability of a foreign government to retroactively change its laws).