The Indian government is in talks with Cairn Energy and Vodafone Group to end the long-running tax disputes with the two companies. This is just after the Indian government revised the Income Tax Act to end retrospective tax claims.

Revenue Secretary Tarun Bajaj acknowledged the talks in an interview with Bloomberg. He denied that the decision to withdraw the 2012 retrospective amendment to the Income Tax Act was connected to the cases.

“We have not been influenced by arbitration matters which are going on in various courts,” said Bajaj. “We want to give stability and certainty on taxation rates to foreign investors.”

The Indian Parliament moved to withdraw the controversial 2012 retrospective tax provision under an August 9 bill allowing amendments, marking a key change for Indian tax policy. The retrospective tax provision allowed the Indian government to pursue tax claims going back all the way to 1962.

There are at least 17 companies embroiled in disputes with the Indian government based on retrospective tax claims. These cases could be settled since this provision has been dropped, but Cairn and Vodafone may be at the top of the list.

Sources close to the Cairn case have told the press that the company may be open to a smaller refund. “Cairn would just want the Indian government to refund the principal amount. The company is willing to let go of the remaining part of the arbitration award,” said the source.

Other sources suggested that this would be a “substantial” reduction and that the company would have to accept this “huge haircut”.

Background

The Indian government has been locked in a battle with Cairn and Vodafone for many years. Both cases go back to transactions from more than a decade ago, yet several rounds in Indian courts have failed to end the disputes.

Eventually both cases went to the Permanent Court of Arbitration in The Hague. The court ruled in favour of Cairn and Vodafone in respective decisions in September and December 2020. But the Indian government decided to fight back.

Taxpayers have gone back to the negotiating table in the hope of finally ending the disputes. However, the Cairn and Vodafone cases will be studied for years because of the precedents they set in Indian tax law.

The Cairn case revolves around capital gains tax on a restructured company sold 15 years 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 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, 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.

The Hague court has ruled in Cairn’s favour, but the arbitration decision has yet to be enforced.

Much like the Cairn case, the Vodafone case goes back more than a decade to a 2007 deal. A crucial difference is that the Indian government amended the Income Tax Act in 2012 after the Supreme Court ruled in Vodafone’s favour.

The primary question was whether gains made by Hutchison on the sale of an Indian telecom network to Vodafone through an offshore share transfer deal were taxable in India. Vodafone argued its case and maintains it was not obliged to withhold taxes on its payment to Hutchison.

The Indian government’s position is to tax the gains of offshore transfers because the shares derived their value from assets located in India. Vodafone Group has been fighting the case for more than a decade despite the Supreme Court victory.

The Vodafone case has become infamous among Indian taxpayers. The case overshadowed the company’s growth plans in India, but other companies began to reconsider their investment plans. This would become a key factor behind the U-turn on retrospective taxation in August 2021.

The Bharatiya Janata Party (BJP) even accused the Indian National Congress (INC) government of unleashing ‘tax terrorism’ against investors. The BJP would later come to power in 2014. Many taxpayers hoped the government would abolish the controversial amendment to the Income Tax Act.

Retrospective taxation has been a controversial tax topic in India since 2012, and it took seven years for the Indian government to change course. The Permanent Court of Arbitration decision in September 2020 might have opened the possibility of fresh negotiations and hastened this political change.

However, investor confidence in India will only rise significantly after Vodafone and Cairn fully settle their retrospective tax disputes. A great deal depends on whether the talks with the Indian government are successful.