Reviving BITs: Reimaging Tax Paradigm

Introduction

Presenting the interim budget for Financial Year 2024-2025, the Union Finance Minister made an announcement which marks a significant departure from the decade old policy stance of the Government of India (GOI). She announced that the GOI is “negotiating bilateral investment treaties with our foreign partners” towards the stated objective of “encouraging sustained foreign investment” with a marked priority that such treaties should be negotiated “in the spirit of ‘first develop India’ ”.¹ There is a lot of history, a rather intricate one, which shall be put behind with this decadal shift in GOI’s policy in relation to bilateral investment treaties (BIT). More critically, there are multiple prisms to dissect the various contours of GOI’s BIT policy. This article attempts to revisit the tax-related dimension of the historical account of Indian experience with BIT.

Vodafone and Cairn BIT awards: Leading the charge against scoping tax in BIT framework

Typically, BITs address the impact of host State’s legislation and governmental action on the investments made by the non-residents in the host States. However, in the absence of any specific carve-outs and given the steering impact of tax incidence on investments, the scope of BITs has been consistently tested to bring tax measures within their ambit. Two major arbitral awards, in Vodafone International Holdings BV v. Union of India² and Cairn Energy Plc and Cairn UK Holdings Ltd. v. Republic of India³, under BIT, both against the GOI, firmly declared that tax laws and policy can indeed be scrutinised and declared as violation of BIT commitments.

In brief, in Vodafone⁴, the Indian tax authorities considered an offshore transaction as leading to capital gains tax consequences in India. This was challenged by Vodafone before Indian courts. After losing initially before the High Court, its challenge was accepted by the Supreme Court in its decision which quashed the demands.⁵ However, the GOI proposed a retrospective amendment of the Income Tax Act, 1961⁶ to nonetheless subject the transaction to tax in India. Instead of challenging these amendments before the courts, Vodafone⁷ initiated proceedings under the India-Netherlands BIT and succeeded before the Tribunal constituted under the BIT.⁸ In Cairn⁹, the same retrospective amendment was applied by the GOI in the wake of the former’s offshore corporate reorganisation. The application of this amendment was challenged under the India-United Kingdom BIT which resulted a similar award against the GOI.¹⁰

The common thread of both awards in Vodafone¹¹ and Cairn¹² was that ordinarily tax was outside the BIT, but the application of tax laws could nonetheless come in conflict with the assurances under the BIT where they resulted in “tax-related investment disputes”. This conclusion is thereafter tested on the touchstone of the fair and equitable treatment (FET) standard to declare whether the impugned tax measures are in violation of the BIT commitments. Simultaneously, this aspect has resulted into another expansion of BIT framework.¹³ This development led to extensive details on the scope of BIT and whether they were in conflict with the “tax sovereignty” of the BIT partners.¹⁴

GOI’s revisit to BIT scope

Perhaps wary of the impending developments, even before the awards were pronounced in the Vodafone¹⁵ and Cairn¹⁶ BIT disputes, the GOI had already taken a policy decision of revisiting the BIT framework and, specifically, excluding tax from the scope of BITs.¹⁷ The 2015 Revised Indian BIT Model¹⁸ specifically excludes “any law or measure regarding taxation, including measures taken to enforce taxation obligations”. Obviating any scope for doubt, it further stipulates that:

[f]or greater certainty, it is clarified that where the State in which investment is made decides that conduct alleged to be a breach of its obligations under this Treaty is a subject-matter of taxation, such decision of that State, whether before or after the commencement of arbitral proceedings, shall be non-justiciable and it shall not be open to any Arbitration Tribunal to review such decision.¹⁹

Simultaneous to this new policy stand, the GOI also terminated all its existing BITs and started executing new BITs on the basis of the 2015 Revised Model, such as in the case of Brazil.²⁰ In other words, the incumbent policy of the GOI is to exclude tax altogether from the scope of BIT.²¹

2024 announcement: Winds of change in the offing

As a prelude to the interim budget announcement, it is interesting to note that even before the announcement the GOI was already in the process of negotiating comprehensive BITs pursuant to the termination of the earlier BITs. While the ongoing negotiations on India-EU BIT are mostly in media reports,²² there is a formal announcement as regards other BITs. For illustration, the 2022 Comprehensive Economic Partnership Agreement between GOI and UAE²³ specifically states that both the Government have agreed to finalise a new BIT.²⁴

The announcement, nonetheless, carries significance. One may be tempted to dismiss these words as superfluous (given that they are generally the objective of all BITs), nonetheless, the announcement that the GOI shall negotiate BITs “in the spirit of ‘first develop India’” carries a significant heft. Firstly, the announcement itself is a change of stance, from a conservative outlook manifesting from the 2015 Revised Model to a more open and outgoing outlook as regards the BIT policy of GOI. Secondly, these expressions imply that GOI can be expected to negotiate BITs in a manner such that the resultant inward investment addresses the growth aspirations of India, particularly the aspiration to attain a “developed country” status by 2047. This could be achieved either by stipulation of conditions or by specifying the sectors in which investments would be entitled to BIT protection.

However, it is not yet clear whether these BITs would be negotiated based on the 2015 Revised Model — in which case they would exclude tax laws and application of tax measures from their scope — or is there a change in the GOI’s stance and tax measures are nonetheless covered within these BITs under negotiation. This aspect is crucial as there appears to be considerable shift in the GOI’s approach to applying tax measures, as marked by the GOI’s 2021 proposal²⁵ to withdraw the application of the 2012 retrospective amendments, which were subsequently approved by the Parliament.²⁶ While moving the Bill for consideration of Parliament, the revisited policy stand of the GOI was firmly evident, insofar as it acknowledged that the “retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors” and stressed that “foreign investment has an important role to play in promoting faster economic growth and employment”.

While it is premature to conclude on the content of the prospective BITs, in the wake of such shift in policy thinking, one cannot be faulted for the hope that tax measures would find their way back in the Indian BITs.

Sharpening FET standard: The way forward

There is a famous saying — Those who do not learn history are doomed to repeat it. The Vodafone²⁷ and Cairn²⁸ BIT awards can be the basis for significant learnings in case one is determined to set things right in respect of the interplay of tax and BIT. This requires a balance between two competing priorities. On the one hand is the consideration that in order to keep BITs meaningful, there should not be a total carve-out of tax from BITs as, after all, tax measures (if not calibrated in their application) can be a direct tool for expropriation, an eventuality protecting against which is the quintessential objective of BIT. On the other hand, simultaneously, there is relative merit in the argument that an unbridled application (read expansion) of the FET standard, that too by certain individuals who are not privy to the welfare agenda of host States, can indeed result in deprivation of tax sovereignty.

The middle path perhaps lies in crystallising the nebulous application of the FET standard into specific parameters (which can be by way of illustrations if not exhaustively) such that tax sovereignty considerations do not repeatedly arise to scuttle a BIT claim against application of tax measures. To exemplify this aspect, for example, the BIT can sharpen the application of FET standard against specific instances which are considered as intrusive application of tax measures, such as prohibiting application of tax legislation retrospectively; pre-enactment consultation with foreign investors; lead time to foreign investors to implement tax law changes; availability of pragmatic exit routes to foreign investors, etc. Such and other similar specific enumerations of what is considered as impermissible application of tax measures can, though not an exhaustive delineation or replacement of the FET standard, can usher confidence amongst the investors expressively better than the current GOI’s stand of whole exclusion of tax from the scope of BIT.

The fact that the budget speech has put on record the clear policy stand of GOI — to go ahead with BIT negotiations — it is in the fitness of things to revisit the 2015 Revised Model’s stance on tax to make these negotiations meaningful and indeed result into increased foreign investment.