Cairn Energy PLC (Cairn) hit the headlines in June 2021 when it announced the take over of the ownership of the Indian Government’s properties in Paris. It was done to enforce the arbitration award won against the Indian Government at an international tribunal in December 2020.
Through this article, we have tried to explain the reason behind such a move made by Cairn and also simplify the entire legal dispute between the two sides- the Cairn Vs India dispute
Cairn is a UK-based oil and gas exploration, development, and production company listed on the London Stock Exchange. Its first investment in India was made in the 1990s and thereafter the Indian oil and gas industry saw a major transformation with more than 40 discoveries of oil fields including the Mangala, Bhagyam, and Aishwarya fields in Rajasthan which contributed to increased production of oil in the country.
In the year 2006, Cairn sought an internal reorganization (change in the structure or ownership of a company by way of merger, consolidation, transfer, etc.). Through the process, Cairn UK set up a subsidiary Cairn India Limited under the Indian jurisdiction and transferred its shares to it.
It has to be noted here that any transfer of capital assets (in this case, equity shares) situated in India attracts capital gain tax under the Income Tax Act 1961 (IT Act 1961). However, the transfer of shares made by Cairn was quite opaque in the sense that Cairn UK is a non-Indian company, and technically its shares are not situated in India. The transfer was also made through multiple intermediaries (much like the Vodafone-Hutch merger in 2007).
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Vodafone had entered the Indian market in 2007 by purchasing Hutch India at Rs.55000 crores. Hutchinson Hongkong (the parent company of Hutch India) sold Hutch India to Vodafone and hence was liable to pay capital gains tax to Indian tax authorities.
As per the Indian tax law, Vodafone should have deducted the amount of capital gains tax from the final payment made to HTL Hongkong and deposited it with the tax authorities.
But it did not turn out that way. This is because HTL Hongkong did not invest directly in India. They invested through an intermediary in the Cayman Islands called CGP Investments (Holdings) Ltd., which owned 67% in Hutch, India. So, Vodafone purchased CGP investments. It effectively made them the owner of Hutch Essar, India.
Vodafone refused to pay capital gains tax in India as it was a transaction carried out in the Cayman Islands between two foreign firms. (The Cayman Islands is a tax haven and imposes no capital gains tax on the sale of assets.)
The tax authorities argued that the transaction involved the sale of Indian assets and was liable to be taxed in India.
UNDERSTANDING GENERAL ANTI-AVOIDANCE RULE (GAAR)
Anyway, subsequently, in 2011, Cairn sold 58.5 % of the shareholding in Cairn India to Vedanta Resources Limited (Vedanta). [Vedanta is a globally diversified natural resources company with significant interests in oil and gas amongst others].
So far, so good
In a major turn of events, the Indian government, in the year 2012, introduced an income tax amendment with retrospective effect from 1 April 1962. As per this amendment, the shares in a foreign company shall be considered to have been situated in India if its value is derived substantially from underlying Indian assets. Hence, with effect from 1962, capital gains from any transfer of shares made by a foreign entity was made taxable, if the assets are located in India
This clearly brought the Cairn Energy-Cairn India deal and the Vodafone-Hutch deal under the Indian tax remit.
As a result of the amendment, the Indian IT Department (IITD) launched a tax investigation into Cairn in 2014 and issued a claim of USD 1.4 billion for unpaid capital gain taxes on the transfer undertaken in 2006. Cairn was also restricted from selling its residual stake in Cairn India.
Meanwhile, Cairn India was merged with Vedanta in 2017.
Cairn’s shares in the merged company including dividends were taken over by the Indian Income Tax Department (IITD). The department sold the shares and received all the proceeds and dividend payments as part of its efforts to recover tax dues.
Consequently, Cairn had no other option but to approach the Permanent Court of Arbitration at Hague arguing that India violated the India-UK Bilateral Investment Treaty (BIT). [The BIT is an agreement made between the two countries to promote foreign investments and it ensures that foreign investors are treated by each country the same as their own nationals.]
The arbitral panel unanimously ruled in favor of Cairn and accordingly issued an award in December 2020 to pay a sum of USD 1.2 billion as damages to Cairn, together with interests and costs (totaling $1.7 billion).
Since then, India has been opposing the ruling and finally, in March 2021 it proceeded with filing an appeal against the award on the grounds of sovereignty. The Indian Government is of the opinion that tax matters fall outside the domain of a BIT and are beyond the jurisdiction of international arbitration.
Cairn registered its award in several nations, including the US, UK, Singapore, France, etc. The award can be enforced against India-owned assets in more than 160 countries that have ratified the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Courts in five of these countries have already given recognition to the arbitration award, which opens up the possibility of Cairn seizing Indian assets in these countries if the Indian Government does not pay the amount.
For instance, in May, Cairn sued Air India in New York to seize its assets and enforce the award. Cairn Energy had earlier claimed that they had identified $70 Billion of Indian assets overseas, which it can seize to enforce the award. As per recent reports, a French court has ordered a freeze on real estate owned by the Indian Government in central Paris based on Cairn Energy’s application.
While Cairn is confident of its legal position, we will have to wait for the conclusion until India’s next step.
[Update 27/1/2022: In August 2021, the Indian Government made another amendment to the Income-tax act. It nullifies the retrospective basis for taxation, that is, capital gains tax on the transfer of shares by foreign entities cannot be imposed on transactions made before 2012. In response, Cairn has withdrawn all tax cases against the Indian Government. The Indian Government will refund Rs.7900 crore or approximately $1.06 billion (collected earlier by the sale of shares and taking over dividends) to the company.
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