Desolated Future Of Investments In India- Disregarding The Vodafone Verdict

By Shobhit Shulka, second-year student at MNLU, Mumbai

India is an attractive destination for foreign investment. However, given the hitherto arbitration regime in the country and uncertainty in smooth enforcement of awards in India, foreign companies are becoming more skeptical about investing in India. Even at a time when the judiciary has been more supportive of arbitration, the government has continued to be incredulous of the practice. The issue has  been further aggravated recently by the Solicitor General of India when he refused to accept the award given by the Permanent Seat of Arbitration in the case of Vodafone International Holdings BV v. The Republic of India (‘Vodafone Judgment’). This post briefly discusses the judicial trend on this issue and analyses the consequences of this orientation by the government towards arbitration.

In a unanimous decision, The Permanent Seat of Arbitration ruled on 25th September 2020 that the Indian income tax authorities had violated the guarantee of fair and equitable treatment under the Bilateral Investment Treaty (‘BIT’) signed with the Netherlands, by retrospectively amending the law to demand Rs. 22,000 crores from Vodafone.The judgement seemed to bring the infamous retrospective tax battle to a close, however, closure is still uncertain. After the declaration of the award, India as a state had two options: 1) To accept the award and close this long pending matter which would suit India’s contention of it being a better place to do business, with a tax-friendly regime for business incorporators and foreign investors. 2) Challenge the award at another international forum and not implement the award as decided by the arbitral tribunal. At this juncture, the government seems more inclined towards the second option, which was affirmed bythe Solicitor General’s comments. However, this might have a severe impact on India’s tax friendly regime and would disincentivise investors and businesses to invest in India, at a time when the deteriorating economic conditions are in desperate need of such investments.

Background of the case

In May 2007, Vodafone bought a 67% stake in Hutchinson Telecommunications (‘Hutchinson’)for an $ 11bn deal, this included the mobile business and other assets of Hutchinson in India. In September that year, the Indian Government raised a demand of about 8000 crores in capital gains and withholding tax from Vodafone saying the company should have deducted the tax at source before making a payment to Hutchinson. Vodafone moved the Bombay High Court which ruled against Vodafone. It then appealed against the order in the Supreme Court, which ruled Vodafone’s interpretation of the law as the correct one and ruled that it did not have to pay any taxes. In an ideal world, the matter would have ended then and there. However, that same year the then Finance Minister came with a proposal to amend section 9(1)(i) of the Income Tax Act and retrospectively tax such deals. The Bill passed the onus on Vodafone to pay the taxes. The Government circumvented the effect of the apex court’s judgment by resorting to retrospective legislation and created an unpredictable and unstable business environment. Vodafone then challenged the amendment under the India-UK BIT and the India-Netherlands BIT. The arbitral award was announced in Vodafone’s favour, finding the Indian government in violation of section 4(1)of the India-Netherlands BIT.A BIT is an agreement between two sovereign states for the protection of investors and businesses from one state to another. The government’s stand has been that tax matters do not come under the purview of BITs. The retrospective law allowed the indirect transfers of Indian capital assets even if the transfer was a sale. Thus, the argument from the government has been that they should challenge the award under the tax treaty because it questions the sovereign right of the government. This award negates India’s general position that tax disputes do not come under the ambit of investment treaties. The Indian Revenue department has thus raised objections over the arbitral award coming under the purview of the BIT and not under the tax treaty.

Options that India has to challenge the infamous award

India stands at a tricky crossroad here as challenging this award seems very unreasonable as the dispute has already been ruled against India by the Supreme Court and then the arbitration tribunal. However, the government’s contention here is that the award seems to challenge its sovereign right to tax and would impact other cases against the government.

Vodafone too cannot enforce its victory and will have to approach Indian courts again, because India does not recognise any foreign court in a commercial dispute that questions the state’s sovereign right to intervene. The Apex Court in State of West Bengal v. Keshoram Industries held that if the terms of an arbitration treaty are inconsistent with India’s sovereign laws, a court will not give effect to such treaty. This has resulted in the lapsing of 70 BITs between foreign governments and India which has lapsed since 2016 and is not being renewed. India’s latest bilateral investment deals, such as the India Belarus BIT in 2018 and the India Brazil BIT in 2020, have largely omitted from their domain, measures relating to taxes or compliance of tax obligations. In the future, India may negotiate vigorously to integrate such exclusions into bilateral investment treaties.

Uncertainty of investment regimes in India

Unless new agreements have been negotiated between India and the related transaction states, new investments in India between foreign investors and the country will cease to gain BIT security. Current investments related to BITs with ‘sunset provision’,which means that the treaties may continue such as, the India Netherlands BIT that specifies, for investments made before the termination, substantial provisions may continue to extend for fifteen years after the termination.  Several of India’s other deals, such as those with the United Kingdom and Mauritius, have identical ‘sunset’ provisions.

However, this uncertainty could affect India’s business with global powerhouses such as the European Union (‘EU’).Talks aimed at reaching a free trade agreement between the EU and India (which may include investor rights provisions) were started in 2007 but allegedly reached a deadlock in 2013.India, even after a request from EU officials, is hesitant so far to briefly expand its BITs with EU countries to fill the gap with any new agreements. The consequence of the termination of these bilateral agreements is not limited to investment into India but by India too. As westbound investment by Indians rises, Indian investors are increasingly looking at BITs to secure their investments and provide have a roadmap to seek any violations in host countries of the promised safeguards. India’s woes, however, are not limited to uncertainties in trading regimes. The dismissal of an international arbitral award may also have a detrimental effect on the future of investments in India.

What this means for future investments in India

New York Convention awards were enforced in India through the Arbitration and Conciliation Act, 1996 (‘Arbitration Act’). Before this, India’s arbitration was afflicted by setbacks, lack of clarification on the grant of temporary relief, no finality on arbitral awards owing to court requests for setting aside, and a belief that arbitrators were not always unbiased and neutral. Though major cities in India may take several more years to become common international arbitration seats such as those in Singapore or Paris, India is becoming an arbitration-friendly jurisdiction.However, refusalto accept such awards by the government could have a severe impact on such ambitions.

An international investment usually includes a trade arrangement (‘Investment Contract‘) between the foreign investor and the host state. Investment arrangements, either before domestic courts or regulatory tribunals or by international arbitration, allow for dispute settlement. Refusing to accept an international arbitration award will disincentivize the investors. Investors will start contemplating on investing in India as any dispute arises the government of such countries might not comply with the international order, putting the investors to losses. It creates a hindrance in the ease of doing business in such countries and thus discourages them to make any investments to indulge in any form of funding

The way forward

The Government has 90 days to file an appeal in Singapore, as the seat of the dispute was in Singapore. At a time when India is in desperate need of investments due to its deteriorating economic conditions, it seemed like it would accept the award and make India seem like a country where foreign investors have a remedy under International Law. However, quixotically enough the government is inclined to challenge the award further, with a slim chance of overturning the award. This could have a severe impact on investor confidence in India and could adversely affect foreign direct and indirect investments in India.

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