Cairn Energy PLC and Cairn UK Holdings Limited (CUHL) v. Government of India: A rising and burning need for investor-State mediation in investor-State tax and energy-related disputes

In the backdrop of the already infamous retrospective taxation regime in India post the Vodafone tax dispute[1], India yet again held to have violated its obligations under the India-UK Bilateral Investment Treaty, 1994 (hereinafter “BIT”) and international law by the Permanent Court of Arbitration, Hague, on 21-12-2020. The Tribunal ordered India to pay US $1.2 billion[2], plus interest and costs, to compensate Cairn Energy Plc (subsidiary of Vedanta UK) and Cairn UK Holdings Limited (hereinafter “Cairn”) for the shares that were sold by the Indian Income Tax Department (hereinafter “ITD”), confiscated dividends, and the tax refunds withheld by ITD. This compensation amount sums up to a whopping US $1.4 billion.[3]

Thus, firstly, this article shall give the factual matrix alongside the arbitral award of the Cairn case[4]. Secondly, this article shall scrutinise the challenges faced by investor-State arbitration in matters related to tax and energy disputes. Thirdly and in finality, this article shall suggest the need for investor-State mediation in energy and tax-related disputes.

  1. Factual matrix and arbitral award in Cairn case

Soon after the Vodafone case[5], in March 2012, the Indian Parliament retrospectively amended Section 9(1)(i) of the Income Tax Act, 1961 by way of Finance Act, 2012. Through this amendment, firstly, the definition of “through” was clarified wherein the term “through” was deemed to be inclusive of “by means of,” “in accordance,” or “by reason of”.[6] And secondly, it was clarified that:

… an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.[7]

In an alternate timeline, in 2006, Cairn UK Holdings Limited (incorporated in UK) (hereinafter “CUHL”) transferred shares of Cairn India Holdings Limited (incorporated in Jersey) (hereinafter “CIHL”) to Cairn India Limited (incorporated in India) (hereinafter “CIL”). Cairn is associated to the oil and gas industry.

On 9-3-2015, ITD claimed that they were able to identify certain unassessed taxable income due to the 2006 transaction of Cairn. The ITD sought to retrospectively implement the 2012 tax amendments and thus, through a draft assessment order, a capital gains tax demand of US $1.6 billion plus interest and penalties was assessed against CUHL.[8]

On 10-3-2015, Cairn Energy instituted international arbitration proceedings against the Indian Government under the India-UK BIT and contended that the guarantee of fair and equitable treatment and protection against “expropriation” given under the BIT has been violated by ITD.[9]

On 13-3-2015, a draft assessment order was passed against CIL due to its failure to deduct withholding tax on the alleged capital gains in the 2006 transaction. The tax demand plus interest against CIL was of US $3.293 billion due to which in January 2016, international arbitration proceedings formally commenced under the India-UK BIT.[10]

In March 2017, the Income Tax Appellate Tribunal upheld ITD’s demand of capital gains tax and in August 2017, CUHL filed an appeal in the High Court of Delhi that is still pending before it.[11]

It is pertinent to note that during the pendency of these arbitration proceedings, ITD seized and held CUHL’s shares (in Vedanta Limited) to an approximate valuation of US $1 billion. Further, CUHL was not allowed to freely exercise its ownership rights over these seized shares and was desisted from selling them. To make matters more perplexing, ITD sold a part of these shares to recover a part of the tax demand made by ITD. The proceeds from this sale came up to about US $216 million. In addition to this sale, to enforce the tax demand of ITD, CUHL’s assets were also seized by ITD.[12]

  1. Analysis: How investor-State arbitration in tax and energy-related disputes is counterproductive

In the present Cairn scenario, we comprehend that it is a case of investor-State arbitration related to international energy sector transactions. This dispute has arisen due to the retrospective taxation regime of India. It is pertinent for us to understand that in complex international energy-related transactions, compliance with various national taxation laws, company laws, and other relevant laws are of quintessence importance. But at the same time, the probability of conflicts arising is high due to a sovereign’s (India) vested interests in these transactions.

The first point of conundrum arises is the conflict between State’s sovereign rights of taxation versus commitments by States under international law. It is a difficult task to ascertain which commitment takes precedence and when. However, there are certain factors through which a thin line may be drawn, and the limits of international law commitments can be defined. This can be in the form of subjective interpretation of the India-UK BIT by the lawyers and tribunals. However, considering the fact that there exists this everlasting conflict between defining the boundaries of sovereignty of a State and its international commitments and the perpetual problem of subjective interpretation of the BIT, an urgent need for coexistence and sustainable relationship between a foreign investor and the host State is mandated. This urgent need seems to be a far goal to be achieved through investor-State arbitration. If the same is replaced with that of investor-State mediation, the aforementioned need can be met as it proves to be highly beneficial to both the parties in terms of their time, resources, and energy. This is because investor-State mediation aims at mutual cooperation and coexistence by way of reaching consensus and settlement.

Investor-State arbitration may seem like a lucrative option but there is a plethora of drawbacks to it. Firstly, the reason why investor-State arbitration is heavily criticised is that a growing trend has been observed wherein an multinational corporation (MNC) is owed in millions or even billions by a host Government because the host Government violated the international law codified in the BITs.[13] In other words, the international arbitral award gave preference to the private interests of profit-making over the public interests and local community.[14] Secondly, it is pertinent to note that these violations by the host Government may have been committed to protect the local community in terms of public health, law and order, economy, and so on.[15] However, this violation for the public good may be disregarded by the international arbitrators.[16] Critics point out that the reason for such disregarding is that these arbitrators do not belong to the local community and fail to comprehend the grassroot-level problems.[17] Thirdly, due to such nuanced issues, investor-State arbitration has created a sense of distrust amongst the local communities of host countries as this type of arbitration does not allow the public to be heard or hear the arbitration proceedings due to party anonymity followed by the fact that only foreign investors can bring claims against the host State and not vice versa. Fourthly, it is also likely that the investor-State arbitration awards may be challenged by the foreign investor outside the Indian courts in case of any future dispute between India and such foreign investor. Fifthly, and in finality, it is possible that an arbitral award may be acceptable to one Government but may not be acceptable to the other Government. Thus, in such complex situations, investor-State mediation is proposed.

  1. Conclusion: Investor-State mediation as the way forward

Investor-State arbitration gained momentum in India once the case of White Industries Australia Ltd. v. Republic of India[18] took place. In May of 2002, the investor-claimant (White Industries Australia Limited) obtained an ICC award against Coal India Limited. For nine years, the investor-claimant sought to enforce this award in India before the High Court of Delhi. However, to the investor-claimant’s respite, no enforcement was provided because of the inordinate delay caused by the traditional courts in India. Thus, the investor-claimant dragged the matter to investment treaty arbitration under the Australia-India BIT 1999 on the ground of inordinate delay. This was done because the inordinate delay led to the violation of various protections given under the Australia-India BIT. This experience led to a paradigm shift in India’s stance on investor-State arbitration.

Initially, India was a signatory of 85 BITs out of which 76 were ratified.[19] However, since March 2017, India terminated 69 BITs to renegotiate the existing BITs in accordance with India’s Model BIT of 2015.[20] Up-to-date, only 12 BITs are in force concerning India i.e. with Bahrain, Bangladesh, Bulgaria, Czech Republic, Latvia, Libya, Lithuania, Romania, Senegal, Serbia, Sudan, and Syria.[21]

Taking into consideration India’s experience with investor-State arbitration in White Industries case[22] and Cairn case[23] did not leave a good taste in the Indian legal regime wherein Cairn’s arbitration award is highly likely to be challenged by India in various international courts,[24] establishment of an investor-State mediation framework becomes imperative.

Thus, from all the aforementioned arguments, we must understand why investor-State mediation is a viable alternative to investor-State arbitration. In investor-State mediation, we observe that the outcome of the process and the control is in the hands of the parties wherein the needs of both the parties are accommodated in a holistic manner. However, in complex processes like litigation and arbitration, the control and outcome of the adjudication process is in the hands of a Judge or an arbitrator. The latter takes away the flexibility in accommodating the interests of both the parties in a holistic manner by also failing to consider the fact that the relationship between the parties should be built in a sustainable manner wherein the culture and traditions of the parties are taken care of. Investor-State mediation offers the best chance at reconciliation and building such a relationship between both the parties as all the necessary cultures and traditions of the host State’s community can be taken into consideration whereas all the profit-making motives of the foreign investor can be addressed mutually.

On the same note, we must address the drawbacks of investor-State mediation. The major challenge faced by it is to gain the foreign investor’s confidence. The best way to gain their confidence is by ensuring foreign recognition and enforceability of mediated settlements. However, the same is extremely perplexed because of the fact that there is no proper international regulatory framework for the admissibility and enforceability of foreign mediated settlements.

The best option available with the parties is to convert the mediated settlements into arbitral awards wherein such arbitral award will be based on the terms and conditions of the mediated settlement as previously agreed by both the parties.

However, when we speak of enforceability of arbitral awards, another issue which pops up is that there is no record or document which shows that an International Centre for Settlement of Investment Disputes (hereinafter “ICSID”) award has been enforced by a host State.[25] Further, according to the ICSID Convention, a State may resort to the invocation of sovereign immunity to block the execution of arbitral awards.

Therefore, this essentially points us in the direction that the converted arbitral awards (converted from mediated settlements) must be in the right direction i.e. in the best interests of both the parties wherein they are satisfied with the respective terms and conditions reached and are consciously willing to enforce the same in the form of an arbitral award alongside building a long-lasting, sustainable relationship. Mediation is slowly taking over the world of dispute resolution and it is not an unknown method to international organisations where even the World Trade Organisation (WTO) has a voluntary mediation procedure. Hence, it would only be right to nudge States towards investor-State mediation for high value disputes involving tax and energy regimes.

† Iram Majid, Director of Indian Institute of Arbitration and Mediation (ILAM) and Executive Director of Asia Pacific Centre for Arbitration and Mediation.

[1]Vodafone International Holdings BV v. India (I), PCA Case No. 2016-35.

[2]Kshama A. Loya, Moazzam Khan and Vyapak Desai, Cairn v. India – Investment Treaty Arbitration  Foreign Investors Continue to Find Relief from Sovereign Retrospective Taxation Powers of States under International Law, Nishith Desai Associates, <HERE>.

[3]Gireesh Chandra Prasad, Centre to Challenge all Cairn Cases in International Courts, LiveMint, <HERE>.

[4] Cairn Energy PLC v. Union of India, PCA Case No. 2016-7.

[5] PCA Case No. 2016-35.

[6]The Finance Act, 2012, S. 4(a).

[7]Ibid.

[8]Supra note 1.

[9]Supra note 1.

[10]Supra note 1.

[11]Supra note 1.

[12]Supra note 1.

[13]Anil Xavier, Investor-State Disputes: Relevance of Mediation, IIAM <HERE>.

[14]Ibid.

[15]Ibid.

[16]Ibid.

[17]Ibid.

[18]White Industries Australia Ltd. v. Republic of India <HERE>.

[19]Rajendra Barot and Sonali Mathur, Investor-State Arbitration: 2020, Mondaq <HERE>.

[20]Ibid.

[21]Ibid.

[22]<https://www.italaw.com/sites/default/files/case-documents/ita0906.pdf>.

[23] PCA Case No. 2016-7.

[24]PTI, India to Appeal against Cairn Arbitration Award: Report, The Times of India <https://timesofindia.indiatimes.com/business/india-business/india-to-appeal-against-cairn-arbitration-award-report/articleshow/81106105.cms>.

[25]Supra note 10.

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