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Government changes tone on Cairn tax case
October, 01st 2015

The income tax department has written to Cairn Energy saying it will be appointing an arbitrator in the $1.6-billion tax demand case soon — apart from the basic tax, interest and penalties also have to be paid, reports fe Bureau in New Delhi.

A few days after finance minister Arun Jaitley announced he would be settling all outstanding tax disputes soon, the income tax department has written to Cairn Energy saying it will be appointing an arbitrator in the $1.6-billion tax demand case soon — apart from the basic tax, interest and penalties also have to be paid, reports fe Bureau in New Delhi. On September 16, the tax department wrote to Cairn conveying this while saying “this is without prejudice to our firm view that the tax disputes referred to in the said notice for arbitration do not fall within the scope of the India-UK BIPA”. How long the final resolution will take is not clear since several arbitration cases involving the government have been pending for two to three years. While Jaitley’s statement suggested the Centre may refer the case, along with others such as Vodafone, to the AP Shah panel, no action has been taken on that front as yet.

The panel had said that said the taxman’s MAT demand on foreign portfolio investors were illegitimate.

On September 23, meanwhile, Cairn approached the International Court of Justice on the matter since, though it had sent the government a Notice of Dispute on March 11, the government had not taken any action for six months. As per the terms, if an arbitrator is not appointed within six months, the other party can approach the ICJ. Once the two arbitrators have been appointed; they will appoint an umpire arbitrator.

The case pertains to Cairn India’s IPO in October 2006 at which point Cairn India was a wholly owned subsidiary of Cairn Energy. Cairn Energy had appointed former Bulgarian minister and lawyer Stanimir Alexandrov — he is associated with a Washington-based law firm — as its arbitrator in April.

The government’s first response, in May, to Cairn’s Notice of Dispute was that “it is the consistent position of India that tax proceedings are not covered by the Bilateral Investment Promotion and Protection Agreements and hence dispute cannot be resolved by arbitration”. When Cairn insisted it could, the government’s next letter said: “Arbitration cannot be invoked prior to the expiry of six months from the date on which the Notice of Dispute is made.”

Cairn Energy’s former subsidiary Cairn India, in which it had invested $5 billion over two decades prior to its sale, today produces nearly a third of India’s crude oil production. Cairn India, which has also been served a tax notice in the same case, is already in court in appeal. The Cairn Energy case pertains to its IPO in 2006. At the time of the IPO, Cairn India was an empty shell of a company and all Cairn Energy’s Indian assets were held by its overseas subsidiaries. Since the idea was to create one big energy powerhouse, Cairn Energy took all the assets from various overseas subsidiaries and housed them in its wholly owned Indian subsidiary Cairn India. As all firms were owned by Cairn Energy, there was no cash outflow from India.

The reorganisation was approved by the Reserve Bank of India, the Foreign Investment Promotion Board and the Securities and Exchange Board of India. Cairn Energy’s argument is that since there was no transfer of shares in 2006, no capital gains were made and no tax was applicable. Once the retrospective tax law was brought in, however, the taxman decided to open up the IPO case.

Cairn Energy’s notice, under the UK-India Investment Treaty, says that under Article 3, India was obliged to “create favourable conditions” and ensure “fair and equitable treatment” and “full protection and security” for Cairn’s investments. This, Cairn argues, was violated by the retrospective tax. Under Article 5, Cairn says, India was obligated not to expropriate Cairn’s investments, but it did so by attaching Cairn Energy’s shares in Cairn India.

Since the value of the Cairn India shares has fallen by over 40% from the $1 billion at the time they were attached, Cairn Energy has also sought damages — according to the company, the income tax notice resulted in an immediate drop in its share price by 43% and caused Cairn significant reputational harm. The inability to realise the value of the shares also prevented it from making other investments.

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