Vodafone's arbitration victory could haunt government

A case that briefly tarnished the image of India as a destination for foreign investors seems to have got closure. The Permanent Court of Arbitration has today ruled in favour of Vodafone Group Plc in the Rs 22,100-crore tax dispute case that started in 2009. The arbitration court reportedly said that the demand for tax is in violation of investment treaty agreement between India and the Netherlands.

The court also directed the Indian government to cease the tax demand (of about Rs 7,990 crore) and interest and penalty (Rs 14,110 crore) against Vodafone Group. The order is expected to bring a huge relief to beleaguered Vodafone Idea which was hurtling from one crisis to another. Also, this is the second breather for Vodafone in less than a month. Early this month, the Supreme Court had asked the Vodafone Idea to pay its adjusted gross revenues (AGR) dues over 10 years against a lump-sum payment.

Though the retrospective tax matter started in 2009, the seeds of this dispute were sown in the historic 2007 deal between Hutchison Essar and Vodafone in which the latter acquired 67 per cent stake in the former's telecom business in India. Two years later, tax department, under the then UPA regime, decided to impose capital gains tax on Vodafone. The matter went to the Bombay High Court which ruled in favour of the government.

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Later, the apex court quashed the Bombay High Court ruling saying that the transaction took place between two non-resident entities at an offshore location (Cayman Islands). "Shareholding in companies incorporated outside India is property located outside India. Where such shares become subject matter of offshore transfer between two non-residents, there is no liability for capital gains tax," erstwhile Chief Justice of India SH Kapadia and Justice Swatanter Kumar had said.

By that time, Vodafone had already paid Rs 2,500 crore to the government in addition to furnishing Rs 8,500 crore bank guarantee. The SC asked the government to return those.

A hell-bent government then decided to change the law retrospectively and brought the tax liability back on Vodafone. Not just Vodafone, this decision also affected auto major Nissan and Cairn Energy - all of whom decided to challenge it in the international arbitration courts.

The government was against the arbitration process as it argued that the laws passed by Parliament do not fall within the ambit of any international treaty, and such arbitration proceedings would be an abuse of the process of law. But order from the apex court paved the way for Vodafone to initiate proceedings.

In 2018, the former finance minister Arun Jaitley had said that the decision taken by previous government to tax Vodafone Group retrospectively was "erroneous" and this is something that the ruling NDA government would be loath to repeat.

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Experts say that the ruling will surely go a long way in restoring global investors' confidence in India's story. "I think it's fair and should have been handled much earlier. Retrospective taxes are not a good indicator of any economy and had it gone the other way, it would have impacted India's image as a country to attract global investors," says Tarun Pathak, associate director at Counterpoint Research.

Also, there could be serious implications for the current government. How? Sonam Chandwani, managing partner at KS Legal & Associates says that while the ruling has stated that the government should stop seeking AGR dues from Vodafone and pay some Rs 40 crore as partial compensation for its legal costs, it would be interesting to observe the implications of this decision on other international arbitration cases over retrospective tax claims and cancellation of contracts against companies like Cairn Energy, and a dozen others if they were to follow suit. "If this were to transpire against the government in dozen other cases, Indian government could end up burning a hole in its treasury for paying damages if it loses," she says.

"The arbitration victory is a setback for the Indian government, the ramifications of which might be even worse as there are a number of other pending arbitrations on the same set of issues. Hopefully, the Indian government will learn from this arbitration that an attractive investment climate requires that they respect the rule of law rather than undermine it," says Nigam Nuggehalli, dean of School of Law at BML Munjal University.

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