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India rebuffs Cairn’s offer to settle tax dispute

Software trouble costs time and money

Cairn Energy has offered to reinvest the arbitration award it won in its transfer pricing battle with the Indian government. Yet India will not accept the proposal because of the precedent the case could set.

Cairn has offered to invest the entire financial award in India, providing that the government relents on the appeal it filed in March. This would include the principal amount of $1.2 billion, plus interest of $500 million.

Although this is a significant sum, Indian government officials have made it clear that the government will not accept this offer. But the government is open to a settlement on different terms.

“There is no way that the government is going to accept the proposal. We have filed an appeal. Any solution will be within the legal framework,” one government official told the press.

“We have asked [the company] to come under the Vivad Se Vishwas scheme and settle the dispute by paying 50% of the disputed principal tax amount and get a waiver of interest and penalty. That would have resulted in an immediate refund of $300 million,” said the official.

The Indian government has filed an appeal with the Dutch Courts of Appeal against the December 2020 decision. The Permanent Court of Arbitration at The Hague ruled unanimously in favour of the taxpayer against the Income Tax Department.

The Indian government argues that the dispute is fundamentally about tax and not investment. This would mean that the case is a domestic matter and not within The Hague tribunal’s jurisdiction.

“There is either an investment dispute or a tax dispute, but there is no precedent for something called an investment-related tax dispute,” said another government official.

When the appeal was filed, Cairn Energy reiterated its “full confidence” in its position and stressed that it would “continue to take all steps necessary in order to protect the interests of its shareholders”.

One reason for India to reject the proposal is that the arbitration decision could set a precedent that could impact similar court cases. A key factor is that the company used the tribunal decision to raise the possibility of asset seizure.

If the government accepted the proposal, India would potentially be left vulnerable in future cases. The Cairn case is yet another reminder of why developing countries are sceptical of arbitration, while taxpayers view arbitration as a way of safeguarding their interests.

Cairn Energy declined to comment on the proposal.

Facts 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 Mangala oil field in Rajasthan 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.

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, Cairn Energy 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 put pressure on the company to concede. It would be five years before Cairn got the ruling it wanted.

The Permanent Court of Arbitration ruled in favour of Cairn over the Income Tax Department. However, the Indian government gave no indication it would comply with the decision. The government has since decided to fight the ruling in the Netherlands.

Either India will succeed in overturning the precedent set at The Hague, or the energy company will consolidate its victory.

The case continues.

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