Going by the speed with which the government eased foreign direct investment norms across 15 sectors on Tuesday, it seems Prime Minister Narendra Modi has decided not to allow the Bihar hangover to affect him for long. Mr Modi’s urgency to lift spirits can also be attributed to his eagerness to embark on a much-hyped trip to the UK on Thursday where another fawning reception by the diaspora awaits him.
At least two British companies would be desperately hoping that Mr Modi is carrying with him some Diwali goodies in the form of a concrete announcement on retrospective taxation. Vodafone and Cairn have been hearing enough pious promises on how the Indian government wants to bury the retro tax ghost, and the UK visit could be a great platform for Mr Modi to walk the talk.
Let’s take the Cairn case. It’s incredible that the government hasn’t found time to name an arbitrator even though the company has been pleading with it to do so over the past few months. The British energy firm had selected its arbitrator in April this year but the government didn’t respond, forcing Cairn to move the International Court of Justice on August 12. Till now, the government hasn’t moved an inch.
The finance ministry is now saying that it is open to an out-of-court settlement on the retro tax issue. Go for it, Mr Modi. In any case, the only out-of-court settlement that the government can reach with Cairn is to withdraw the absurd tax claim.
Here is why. As Cairn’s arbitration notice says, India has breached its obligations under the UK-India treaty promotion and protection of investments by retroactively applying a newly enacted capital gains tax law to an internal corporate reorganisation undertaken in 2006, as a result of which Cairn Plc had to fire 40 per cent of its staff and defer investments.
Cairn is also suffering on account of the government's decision to freeze its 10 per cent shareholding in its former subsidiary, Vedanta-controlled Cairn India. The shares were worth $1 billion when they were frozen and the value has eroded significantly as Cairn India's shares have fallen in step with plunging oil prices.
Cain is therefore right in claiming that the government has failed in ensuring its investments fair and equitable treatment; expropriated Cairn’s investments in violation of the Treaty, by illegally attaching its equity shares as well as any receivables by Cairn from Cairn India.
Prior to listing Cairn India, Cairn undertook an internal reorganisation and fully disclosed the details in its application to the Foreign Investment Promotion Board (FIPB) in August 2006. The FIPB’s practice was to provide a copy of such an application to the income tax (I-T) authority to assess the proposed transaction for tax implications. While Cairn’s FIPB application was granted in September 2006, the I-T department did not make any demand for capital gains tax because no such tax was applicable to a transaction in shares in an offshore company that was purely internal to the corporate group.
Cairn India likewise disclosed the details of the reorganisation directly to the I-T department in its tax filings for the assessment year 2007-2008. Again, the I-T department made no demand for capital gains tax. The reorganisation was later analysed by the Additional Commissioner of Income Tax, which concluded in its transfer pricing order of October 2010 that it was “in accordance with the approvals in this behalf received from the FIPB and from other relevant regulatory authorities in India and as per applicable valuation norms.”
Cairn also paid capital gains and other taxes on three sales transactions involving Cairn India shares between 2009 and 2012, all of which were scrutinised by the tax department without raising any concerns about capital gains tax being due on the original reorganisation.
On January 15, 2014, armed with a new legislation, the investigation wing of the I-T department conducted “survey” at Cairn India’s premises in Gurgaon. Days later, the Deputy Director of Income Tax in New Delhi notified Cairn in Scotland that during its survey, the investigation wing had “found” new information indicating that Cairn failed to report capital gains taxable in India arising from transactions in shares during the course of the 2006 internal reorganisation.
The Deputy Director also informed Cairn that it was attaching Cairn’s equity shares in Cairn India (worth approximately 1billion) as an enforcement measure. Contrary to the Deputy Director’s indication that new information had been “found” during the survey that justified these notices, the only information actually cited in those notices had already been fully disclosed to multiple agencies of the government in 2006, including directly to the income tax department. It was also publicly disclosed in Cain India’s 2006 Annual Report.
Despite protestations made to the contrary by both the prime minister as well as the finance minister, on March 10, 2015, the I-T department issued a draft assessment order against Cairn in respect of fiscal year 2006/07 for $1.6bn). There is thus no doubt that the order is flawed and unfair as it is brought primarily on the basis of information long available to the tax authorities. The Assessing Officer’s analysis and the payment amounts that relate to the transactions for which he claims capital gains tax are all based on documents, including financial statements and tax filings that were made available to the Indian authorities at the time of the internal reorganisation.
The attachment of the Cairn India’s shares has also significantly adversely impacted the assets of Cairn as the attached shares have depreciated in value by several hundreds of millions of US dollars during the term of the attachment; Cairn had intended to dispose of the shares shortly after the time of the attachment, when the price was much higher than now. Similarly, the disclosure by Cairn of the income tax authority’s actions resulted in an immediate drop in Cairn’s share market value by 43 per cent.
The application of the retro tax to Cairn was particularly arbitrary because no shares or assets of Cairn were sold to any third party nor were any capital gains earned. If Cairn had no expectation that a purely offshore transaction could be subject to capital gains tax in India, the taxation of intra-group transactions, that did not involve any sale to third parties or the accrual of any profits or gains, was even more unforeseeable and unjust.
The arbitrary and unjust treatment of Cairn is underscored by the fact that fresh tax obligations have been applied to transactions over seven years after the government had fully approved those transactions. The I-T department’s allegations that it found evidence only in January 2014 in respect of the internal reorganisation in 2006, is baseless as in fact that transaction had already been fully disclosed to multiple agencies.
Given the absurdity of the case and in keeping with the festive spirit, Mr Modi would do well to invite Cain Plc and its shareholders to his Diwali party in the UK.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
