Cairn Energy retro tax case: Sad reality of doing business in India
July, 14th 2016
Enough has been written about the $5.6 billion tax-demand on Cairn Energy Plc to know how unfair it was. Not only because it was based on the retrospective tax brought in by the UPA, but also because IPO proceeds are never subject to a capital gains tax. In this case, Cairn Energy held all its India assets through overseas companies in tax havens and it transferred these to a new company Cairn India which then did an IPO—since some part of the transfer also involved a cash payment at par value, the taxman based his calculation of a capital gains on this; had Cairn known there was going to be such a large capital gains tax, it could simply have done the IPO in the UK instead of creating value for Indian shareholders. The case was also unfortunate since, while the government created a special panel to look at all new applications of the retrospective law—against which it had campaigned prior to the elections—the case was never brought to the panel on grounds that it was not a ‘new’ case.
What is even more worrying, as Cairn has brought out in its ‘statement of claim’ before the international arbitration panel is that the government had cleared its deal—and all the processes in between—without ever raising the issue of taxation. In September 2006, six months prior to its IPO, Cairn Energy went to the FIPB—which has representatives of the finance ministry on it—and gave it the details of how the corporate restructuring was to take place between various Cairn companies and Cairn India. The FIPB cleared this, but did not even once mention the possibility, leave alone certainty, of this attracting any taxes. Worse, since the share transfers were taking place between two related parties, under the income tax law, they had to be scrutinised by a transfer pricing officer (TPO). Even at this stage, prior to the IPO, the taxman never told Cairn that a tax had to be paid on the transaction. The taxman got another chance to do this later, in 2011, when Cairn sold a 40% stake to Vedanta. All the papers were given to the taxman—a tax of $536 million was paid on this transaction—but even at this point, no mention was made of the tax on the IPO. Cairn goes on to cite India’s aborted attempts to introduce a Direct Taxes Code—and these clearly show that the principle of taxing ‘directly or indirectly’ the sale of an asset located in India were not on the statute at that point. In any case, unlike, say, the Vodafone case where a payment was made to Hutch for buying its Indian assets, the Cairn case was a business reorganisation and so was not liable for taxation anyway.
One justification for the government not repealing the retrospective taxation proposal could be that it didn’t want to appear corporate-friendly and would rather the case be decided by a neutral arbitrator. While that sounds plausible, it flies in the face of the government trying to delay matters by not appointing arbitrators on time. Worse, should the arbitration award go in Cairn’s favour, there is no guarantee the government will honour it. All international arbitrations have to be executed in India, which requires sanction by the court. In a recent case where the international arbitrator ruled against ISRO arm Antrix and awarded $672 million in damages to Dewas Multimedia Limited, Antrix went and challenged this in court—so even if Cairn Energy wins, its shares in Cairn India will remain frozen till the government wants them to. That’s a really sad reflection of the realities of doing business in India.