In today's Finshots we talk about the Cairn arbitration award that's making a lot of people nervous.
The Story
Cairn is a global oil and gas exploration company and about a decade ago, they decided to restructure their Indian operations.
The exact details of the transaction are rather complicated. But here’s a crude and less complicated version if you still want to make sense of things. Cairn Energy, a company based out of Scotland held all its Indian assets (including some of India’s richest oil fields) through a web of Indian entities. Then in 2006, they decided to transfer these assets to a new entity called Cairn India. The transfer was quite opaque and it involved multiple intermediaries.
And while Cairn only transferred the assets between companies it fully owned at the time, there was some confusion regarding the assets’ true value. Tax authorities believed the company’s actual investment in acquiring these assets only tallied up to about ₹2,000 crores. But by 2007, Cairn India had gone public and raised ~₹5000 crores from Indian investors on the back of these very same assets. Clearly, they were worth a lot more than ₹2000 crores. How much more you ask? Authorities believed their true value amounted to ~₹26,000 crores. And if a transfer involves monetary gains, then the taxman will want his cut.
Unfortunately, tax authorities did not make this demand back in 2006. They didn’t do it in 2007 either. In fact, they didn’t do it until 8 years later. And to see why it took them so long, you have to look someplace else.
In 2007, tax authorities were scrutinizing another famous transaction. At the time, Vodafone managed to access Hutchison’s Indian telecommunication assets for a massive monetary consideration without actually paying any tax. And they did it by relying on a web of intermediaries, much like Cairn. The tax authorities cried foul and they wanted Vodafone to pay up. Soon the matter was brought before the Supreme Court, where the discussion largely revolved around one subject — Was this a deliberate case of tax avoidance or was it simply prudent tax planning? After all, if Vodafone had designed the transaction in a deliberate ploy to avoid taxes, they could be held liable. But if they could prove they had simply executed the transaction without ill intention, maybe they’d get some reprieve. And after lengthy deliberations, the Supreme Court opined that the transfer did not amount to tax avoidance and Vodafone no longer had to pay the taxman.
But then, the government did something quite unpredictable. They introduced a new tax bill amending existing regulations all in an attempt to force Vodafone to pay up their “alleged” dues. It was retrospective legislation — meaning, it gave tax authorities the leeway to reassess transactions dating back to 1962. And that’s where Cairn comes in.
Tax authorities realised they could get Cairn to pay up since the new tax code would be applicable to the 2006 transfer as well. And when Cairn refused to comply, they went a step further. But before we get to that, a quick reminder that Cairn had already sold most of its assets to Vedanta by this time. Cairn Energy — the parent company only owned about 10% of Cairn India and they would have sold that too if it weren’t for the tax authorities. But since Cairn was being uncooperative, tax authorities seized what little Cairn owned in India and sold 'em off. Cairn also believed they were entitled to a tax refund. Tax authorities simply said —" Nope, no refund for you."
Anyway, the company had only one other recourse. They had to take the matter international. And that is precisely what they did.
They approached the permanent court of arbitration at Hague contesting that the amendment of the tax code amounted to a gross violation of fair and equitable treatment promised under the India-UK Bilateral Investment Treaty (BIT). And the court agreed that this was in fact a gross violation. They’ve now asked the Indian government to fully compensate Cairn — for selling the assets and not awarding the refund. All in all, the court has asked the Indian government to pay up $1.2 billion plus interest and costs.
But the problem with these international rulings is enforcement. After all, India has always contested that a tax demand such as this cannot be adjudicated by a foreign court i.e. If the legislators decide to pass a law, then all entities within the state are bound to honour it. However, on this particular occasion, Cairn has threatened to seize government-owned assets abroad if they are not compensated in full. Granted, it’s easier said than done, but it’s making a lot of people sweat here in India.
And while the government has stated that they will appeal the ruling, it’s increasingly seeming like they are trying to sort out the matter internally. So yeah, that's the crux of the matter here, but tell us what you think?
Is the government pursuing a lost cause? Or should the likes of Cairn fall in line? Let us know your thoughts on Twitter.
Until then...
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