The Permanent Court of Arbitration at the Hague has finally ruled in favour of the telecom giant Vodafone in an investment treaty arbitration (ITA) dispute against India, initiated under the India-Netherlands Bilateral Investment Treaty (BIT).

This ruling marks the culmination of almost a decade long bitter tax dispute between India and the Vodafone Group. While the arbitral award has yet not been made public, it is worthwhile to take a look at the history of the dispute and the implications of the ruling for India.

The tax dispute in India

The Dutch affiliate of the Vodafone Group, Vodafone International Holdings B.V. (VIH) acquired 67% interest in the Indian telecom company Hutchison Essar Limited (HEL) for $11 billion. This transaction took place in 2007, through an agreement between VIH, and the Hutchison Telecommunications International Limited (HTIL) involving a Cayman Island-based company CGP Investments Limited (CGP), which in turn, directly and indirectly, held 67% interest in Hutchison Essar Limited (HEL), the Indian company. Soon after, the Indian income tax authorities issued a notice demanding payment of $2.2 billion as capital gains tax, which Vodafone contended it was not liable to pay as the transaction between HTIL and VIH did not involve the transfer of any capital asset situated in India.

The matter went up to the Bombay high court, which decided that Vodafone was liable to pay the taxes as claimed by the income tax authorities. On appeal by Vodafone, the Supreme Court in 2012 reversed the Bombay HC judgment and held that the company was not liable to pay any tax.

Internationalisation of the dispute

In an ideal world,  the matter should have come to an end. However, very soon the Finance Bill 2012 was introduced in parliament seeking among other things, amendment of Section 9 and Section 12 of the Income Tax Act 1961 – the interpretation of which was the foundation of the Supreme Court judgment. The Bill became law and the aforesaid sections were amended retrospectively and given effect from 1961. Following the amended Income Tax Act 1961, the authorities renewed the tax demand on Vodafone, at which point VIH resorted to the first investment treaty arbitration under the India-Netherlands BIT in 2012.

Vodafone argued that the imposition of tax claims through retrospective amendment, even when the final word had already been said by the Supreme Court, amounts to a violation of fair and equitable treatment (FET) promised under the India-Netherlands BIT. The India-Netherlands BIT in its Article 4.1 provides that the investors shall at all times be accorded fair and equitable treatment, which includes an obligation to ensure a stable and predictable regulatory environment.

In other words, when the Supreme Court has decided a dispute, it would be presumed that a matter has attained finality. However, circumventing the effect of the apex court’s judgment by resorting to retrospective legislation, certainly creates an unpredictable and unstable business environment. The Indian government just did that.

The Supreme Court of India. Photo: PTI

Second ITA dispute

In 2014, when the new government came to power, it criticised the retrospective changes that had been made to the taxation laws but did nothing to change that. Until, 2017, India had been dragging its feet in the arbitration, when it woke up to the shock of second ITA dispute filed by Vodafone under the India-UK BIT challenging the retrospective imposition of the capital gains tax.

The Indian government approached the Delhi high court seeking an anti-arbitration injunction against Vodafone to keep it from initiating arbitration under the India-UK BIT. India argued that this would amount to an abuse of process as two different arbitrations on the same issue would amount to parallel proceedings, and would run the risk of inconsistent awards. Initially, the Delhi HC granted an ex parte interim order on August 22, 2017 restraining arbitration under India-UK BIT. However later, on May 7, 2018, the Delhi HC in final judgment dismissed the plea of the government seeking an anti-arbitration injunction on the ground of abuse of process.

What weighed heavily on the mind of the court to dismiss the government’s plea of abuse of process was the offer made by Vodafone to consolidate the arbitrations under the India-UK BIT and the India-Netherlands BIT. The court held that such an offer and undertaking is sufficient to placate India’s concerns regarding double relief which may be granted by two tribunals in respect of the same matter.

The award

The arbitral award rendered in this case finds the Indian government in the violation of the FET standard under Article 4(1) of the India-Netherlands BIT. While the Indian government has not been asked to pay any compensation, it has been asked to pay around Rs 40 crore as partial compensation for the legal cost, and to refund the tax which has been collected so far.

However, the Indian government can still approach the High Court of Singapore requesting it to set aside the arbitral award, given that the seat of arbitration was in Singapore.

Important to note that the Supreme Court while deciding the case in favour of Vodafone observed and emphasized that:

‘FDI flows towards the location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system.’

Quixotically enough, the then UPA government went ahead and turned the table on its head, and the present government criticised the previous government for turning the table, stressed the need of turning the table but sat on it instead.

The Supreme Court has observed that certainty is integral to rule of law. Photo: Libreshot

India is now signing BITs either based on the 2016 Model which has a highly restrictive ITA provision, or which do not have ITA provisions at all, such as the India-Brazil BIT. However, even the BITs which India has already terminated continue to protect the foreign investors for the next 10-15 years. Hence, as India does not seem to disengage itself from international investment law altogether, it would do well to ‘internalise’ international investment law, and BITs as a matter of policy. The Vodafone dispute underscores this need more than ever.

Whatever measures the government takes which may affect foreign investors, it must take into account, the obligations which it agreed to under the BITs. That requires all the ministries and departments to coordinate with the Ministry of Finance, which is the nodal ministry for BITs and related matters. What is required is sustained inter-ministerial coordination, not after the ITA case is brought, but even before, when a governmental measure is contemplated which may potentially affect foreign investors. This would also require capacity building and training of the government officials concerning international investment law.

Pushkar Anand is Assistant Professor at the Faculty of Law, University of Delhi.