PCA Decision on Retrospective Taxation by India

• 26 Sep 2020

Why in News

The Permanent Court of Arbitration (PCA) at The Hague (Netherlands) ruled that India’s retrospective imposition of a tax liability, as well as interest and penalties on Vodafone Group for a 2007 deal was violation of the Bilateral Investment Treaty with Netherlands and the arbitration rules of United Nations Commission on International Trade Law (UNCITRAL).

Key Points

• About the Case:
  
  • In May 2007, the British telecommunication company Vodafone Group had bought a 67% stake in a company called Hutchison Whampoa.
  • For this, the Indian government for the first time raised a demand of capital gains and withholding tax from Vodafone, under the Income Tax Act of 1961. The government argued that Vodafone should have deducted the tax at source before making a payment to Hutchison.
    
    • Capital gains tax : It is the tax paid on income that derives from the sale or exchange of an asset, such as a stock or property that's categorized as a capital asset.
  • In 2012, the Supreme Court ruled in favour of the Vodafone Group.
  • Later, the Finance Act was amended (2012) giving the Income Tax Department the power to retrospectively tax such deals.
  • Vodafone then initiated arbitration in 2014 invoking the Bilateral Investment Treaty signed between India and the Netherlands in 1995.
  • Ruling: The International Arbitration Tribunal at Permanent Court of Arbitration ruled that the government’s demand is in breach of fair and equitable treatment.
    
    • The government must cease seeking the dues from Vodafone.
    • This was a unanimous decision meaning that India's appointed arbitrator also ruled in favour of Vodafone.
  • Future Course for India: India has said it would study the order and all its aspects and take a decision on further course of action including legal remedies before appropriate fora.
    
    • According to Indian Government, as Vodafone had not paid the initial tax demand and interest and penalty on it, the question of India paying back the amount does not arise.
    • India has the option to move to Singapore International Arbitration Centre as well.
• Retrospective Taxation:
  
  • It allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.
  • Countries use this route to correct any anomalies in their taxation policies that have, in the past, allowed companies to take advantage of such loopholes.
  • Retrospective Taxation hurts companies that had knowingly or unknowingly interpreted the tax rules differently.
  • Apart from India, many countries including the USA, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies.
• Bilateral Investment Treaty:
  
  • On 6^th November, 1995, India and the Netherlands had signed a BIT for promotion and protection of investment by companies of each country in the other’s jurisdiction.
  • The two countries would ensure that companies present in each other’s jurisdictions would at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other.
  • The BIT between India and the Netherlands expired on 22^nd September, 2016.
  • Relation to Vodafone Case: Vodafone invoked BIT as its Dutch unit, Vodafone International Holdings BV, had bought the Indian business operations of Hutchison Telecommunication International Ltd. This made it a transaction between a Dutch firm and an Indian firm.
• United Nations Commission on International Trade Law:
  
  • UNCITRAL was established in 1966 as a subsidiary body of the United Nations General Assembly (UNGA).
  • It is the core legal body of the United Nations system in the field of international trade law.
  • Mandate: To further the progressive harmonization and modernization of rules on international business and reform commercial laws.
  • It adopted the UNCITRAL Model Law on International Commercial Arbitration in 1985 and the UNCITRAL Conciliation Rules in 1980.
  • The UNGA has recommended the use of the said Model Law and Rules in cases where a dispute arises in the context of international commercial relations and the parties seek an amicable settlement of that dispute by recourse to conciliation.
  • India has also incorporated these uniform principles of Arbitration and Dispute Resolution (ADR) in the Arbitration and Conciliation Act, 1996 which has been amended several times.
    
    • The Arbitration Act provides for ADR mechanisms like arbitration, conciliations, etc. for national and international stakeholders.

Significance

• Vodafone’s win in the arbitration against the government in the retrospective taxation is very significant as it may cause other similarly placed companies to seek arbitral reliefs.
• India is entangled in more than a dozen such cases against companies over retrospective tax claims and cancellation of contracts. The exchequer could end up paying billions of dollars in damages if it loses.
• To reduce future arbitration claims, India has ended such bilateral investment agreements with over 50 countries and is working on a new law to protect foreign investors by offering relief from possible policy changes even as it upholds the right to tax them.
• The victory of Vodafone at PCA may provide it some relief as the telecom sector is already facing a number of issues and challenges. The ruling comes days after the Supreme Court allowed a period of 10 years for telecom companies to clear Adjusted Gross Revenue (AGR) related dues, causing heavy financial burden on the telecom sector.

International Arbitration Tribunal

• It is an independent non-governmental panel of independent and impartial experts.
• It generally comprises three members nominated by the Parties (or appointed by the International Arbitration Institution, or by a National Court) on the basis of their legal and practical expertise and knowledge, to render a final and binding award.

Permanent Court of Arbitration

• Established in: 1899.
• HQ: The Hague, Netherlands.
• Purpose: It is an intergovernmental organization dedicated to serve the international community in the field of dispute resolution and to facilitate arbitration and other forms of dispute resolution between States.
• Structure: The PCA has a three-part organizational structure consisting of:
  • Administrative Council - to oversee its policies and budgets,
  • Members of the Court - a panel of independent potential arbitrators, and
  • International Bureau - its Secretariat, headed by the Secretary-General.
• Funds: It has a Financial Assistance Fund which aims at helping developing countries meet part of the costs involved in international arbitration or other means of dispute settlement offered by the PCA.

Way Forward

• India needs to craft meaningful and clear dispute resolution mechanisms in cross-border transactions to prevent the disputes from going to international courts, and save the cost and time expenditure. Improving the arbitration ecosystem will have a positive impact on ease of doing business.

Source: IE