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India decides to fight Cairn arbitration decision

Every case sets a standard

The Indian government will appeal the arbitration decision to award Cairn Energy $1.4 billion in a transfer pricing dispute after negotiations between the company and the government failed to produce a compromise.

The Cairn case is not over despite almost a decade in the courts and subsequent talks between the Indian government and the energy company to try and settle the claim. The government is appealing the decision in case Cairn tries to claim its award.

One government official told the media that “just in case enforcement proceedings are initiated, India is confident to address them and will strongly defend its interests and sovereign rights”.

The Permanent Court of Arbitration at The Hague ruled against the Income Tax Department on December 23 2020. Facing growing unease among its shareholders, Cairn Energy has identified the Indian state assets it could claim as payment for the $1.4 billion arbitration award.

The company has also turned to other countries for support. Courts in five countries, including the UK and the US, have since recognised Cairn’s claim to the arbitration award. Nevertheless, the Indian government is sticking to its position in the case.

“Cairn had set up a tax abusive structure and did not pay taxes anywhere in the world on the gains that it made in India,” said the government official, according to media reports. “It was well within India’s sovereign powers to redress the situation of double non-taxation and tax abuse.”

Cairn CEO Simon Thomson travelled to Delhi to meet with Finance Minister Nirmala Sitharaman and then Finance Secretary Ajay Bhushan Pandey in February 2021. Unfortunately, the talks did not produce an agreement to finally end the dispute and the hopes of a solution were dashed.

However, the Indian official stressed that the government is still “open to a constructive settlement of tax disputes within the existing legal framework”. It may take yet another round in court to end this case once and for all.

Background of the case

The Cairn case revolves around capital gains tax on a restructured company sold a decade ago. The Edinburgh-based company restructured its operations in India and transferred ownership of its Rajasthan oil field to Cairn India in 2006.

As part of the plan, Cairn India acquired the entire share capital of Cairn India Holdings from Cairn UK Holdings in exchange for 69% of its shares. The company argued this was a business reorganisation with no tax motive driving it, but the Indian Tax Department saw it differently.

In 2011, Cairn Energy sold most of its holding in the Indian unit to billionaire Anil Agarwal’s Vedanta Resources for $8.7 billion. However, the tax authority barred the company from selling the residual stake of 9.8% and the government froze the dividend payments from Cairn India to Cairn Energy.

The Indian government retrospectively amended the tax rules in 2012 to grant itself the power to go after merger and acquisition (M&A) deals all the way back to 1962 if the underlying assets were in India. “The 2012 amendment muddied the waters for everyone,” said Chitranshul Sinha, partner at Dua Associates.

In 2014, the tax department argued that the UK oil and gas company owed $1.4 billion in capital gains tax from the flotation of its Indian subsidiary on the Bombay Stock Exchange in 2007. The tax authority would later seize 10% of Cairn India’s shares, valued at around $1 billion, in pursuit of back taxes.

After failing to resolve the matter through the Indian judiciary, the Edinburgh-based company filed a dispute under the UK-India investment treaty and sought international arbitration that started in 2015 for the losses over expropriation of its investments in India from the minority holding.

Despite attempts to reach a $600 million settlement, the case continued and the government tried to raise pressure on the company to concede. It would be five years before Cairn got the ruling it wanted.

The Permanent Court of Arbitration at The Hague ruled in favour of Cairn over the Income Tax Department. However, the Indian government gave no indication it would comply with the decision. As a result, the case will continue in Singapore, where the Indian authorities have also appealed the Vodafone case.

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