The Leaflet | 26 April 2021
India has been short-changed by Vodafone and Cairn arbitral awards
by Ashish Khetan
The international economic law regime has stripped India of over $3.8 billion in taxes due by Vodafone and Cairn Energy. This perverse regime has led to foreign corporations taking advantage of legal loopholes to deny third-world countries their due share of revenue. Worse, it has fettered the sovereignty and regulatory powers of host countries, giving foreign investors the right to sue them before private tribunals, making it one-way traffic—all rights, but no duties for foreign investors—writes author and lawyer ASHISH KHETAN.
WE are watching, despairingly, the spectacle of thousands of Indians dying due to a lack of hospital beds, anti-viral medicines and oxygen cylinders. Covid-19 has exposed the absence of critical resources in India, where even before the pandemic struck, 60 percent of the population lived below the poverty line.
According to some estimates, since the Covid-19 pandemic began in March last year, another 100 million Indians have been pushed below the poverty line. Over the next few years, India will have to find the finances to not only battle the pandemic but also to bring its economy back on the rails and provide for its poor and needy.
But even as India struggles to raise the finances to buy vaccines, secure essential medical supplies and bolster its health and medical facilities, it is cruelly slapped with two arbitral awards passed in recent months by private arbitrators appointed by the Permanent Court of Arbitration, a quasi-inter-governmental body in The Hague, Netherlands. The awards have asked India to forego over $3.8 billion in taxes due by two foreign corporations—Vodafone and Cairn Energy.
India has already spent millions of dollars defending the two legal cases. Plus, it has been ordered by the Tribunal to reimburse to Vodafone £40 lakh pounds, this being 60% of Vodafone’s legal costs.
The tax revenue India has been asked to forego would have been enough to vaccinate 760 million people (if the cost of one vaccine shot is pegged at $5).
Even as Vodafone and Hutch got away from paying capitals gains tax in India, in Nepal a Swedish telecom company has recently been made to pay the US$182 million capital gains tax (CGT) bill that it was issued by Nepal’s tax authority when the Swedish company transferred its indirect shareholding in a Nepalese telecom company held through shell companies floated in St Kitts and Nevis—offshore tax haven– to a Malaysian multinational company. Unlike the Supreme Court of India which discharged Vodafone of its capital gains tax liability, the Supreme Court of Nepal ruled that the Swedish was liable to pay CGT. The lesson for India is: If Nepal can do it, then so can we.
The current international economic law regime was constructed entirely to give priority to the financial and business interests of the capital-exporting developed world. This has superseded concerns related to human rights, environment protection and tax revenue of the developing world.
One may refer to the work of Prof M Sonarajah of National University, Singapore, to understand how the West expanded both the jurisdiction and norm-making of investment law, subjugating much of the developing world to arbitrary and unfair rules written unilaterally by a small club of private arbitrators.
As a result, for the past several decades, a combination of double taxation avoidance agreements (DTAAs) and bilateral investment treaties (BITs) have been bleeding the developing world of its much-deserved and needed revenues.
There are currently more than 3,500 BITs and 3,000 DTAAs in force globally. Illegit interests of wealthy individuals and corporations, camouflaged as investment protections and prevention of double taxation, have been trumping the development needs of poor countries like India.
The Vodafone and Cairn arbitral awards only highlight the perverseness of the current economic law regime of which the poor living in developing countries have been the worst victims.
Cozy Club of Arbitrators
So what is the background and context leading to $3.8-billion awards slapped against India? These Tribunals were not of the nature of an international court. Those who presided over arbitrations were not tenured judges or judicial officers. They are part of a small, cozy club of practising lawyers or academics, known as “repeat arbitrators”. They preside over arbitrations in capricious secrecy, with proceedings not open to either public or the press.
While presiding over multi-billion-dollar arbitration cases between private parties and States, the arbitrators do private consultancy, work with law firms or write books promoting international economic law which many believe is unfair and inequitable, favouring rich corporations over poor nations.
The arbitral award in favour of Vodafone and against India was passed by LY Fortier, F Berman and R Oreamuno Blanco—the first two are private counsels with a flourishing commercial practice.
The investor-state arbitral proceedings are almost always confidential, with even final awards not placed in the public domain. In both the Vodafone and Cairn orders, only a few operative paras have been made public.
The Indian public would never know the legal reasoning on the basis of which they have been denied 4 billion dollars in tax revenue, which could have been used to build hospitals and roads for them and schools and colleges for their children. Under the extant rules, the grounds on which such arbitral orders could be challenged are very limited and narrow and mainly procedural in nature.
“The result is that annulment committees and courts have upheld some awards, even when they took the view that the reasoning of the initial tribunal was ‘wrong’ as a matter of substantive law. For example, the annulment committee in CMS v. Argentina (2007) explained that, given its limited mandate, it could not annul parts of the arbitral tribunal’s award even though it ‘contained manifest errors of law’.” (The Political Economy of the Investment Treaty Regime, Oxford)
In the late 80s and early 90s, India and many other developing countries signed dozens of BITs, and DTAAs with capital-exporting countries in the West. At the time India was a small economy with very little geo-political heft. It had little room to negotiate the fine print of these treaties as it desperately needed foreign investments.
India signed these treaties on the terms dictated by the western world. Most of them were signed by mid-level government officials with almost no public discussion, least of all parliamentary debate.
The West argued that these treaties were important before their corporations could make investments in countries like India. They argued that their investors should not be treated unfairly or inequitably or discriminated against vis a vis domestic investors. The BITs or DTAAs, however, were never supposed to become instruments to evade taxes or circumvent the domestic law of host countries.
No BIT, on the face of it, states that foreign corporations should take advantage of the legal loopholes to deny third world countries their due share of revenue. But this is exactly what has transpired for the past three decades and what the Vodafone and Cairn cases in essence amount to. Worse, the investment treaty practice has severely fettered the sovereignty and regulatory powers of host countries, giving foreign investors the right to sue them before private tribunals while imposing no corresponding obligations on the investors. It’s one-way traffic—all rights, but no duties for foreign investors.
The whole system is rigged. A well-oiled industry of tax experts and investment lawyers has been structuring foreign direct investments made by multinationals like Vodafone and Cairn in developing countries like India. It is being done in such a way that they don’t have to pay any taxes at all or at the very least, get away by paying a minimal amount of taxes in host countries where the investments are made.
Look at the Vodafone controversy. When Hutchinson Telecommunications first invested in the telecom business in India and later Dutch-based Vodafone International Holdings bought over its Indian telecom business, the shares that changed hands were of an investment holding company incorporated in the Cayman Islands– CGP Investments.CGP Investments, in turn, held various underlying subsidiaries in Mauritius, which ultimately held a controlling stake in Hutchison Essar Ltd—the Indian telecom company.
Now why would a Dutch or a Hong Kong investor invest in India through companies floated in the Cayman Islands and Mauritius? It’s simply because they didn’t want to pay India their due share of taxes—especially capital gains tax and dividend withholding tax. But there were other benefits too such as exemptions or reduced tax rates outflowing interest and royalty payments (all such benefits are known as “profit shifting and base erosion” devices).
Also, structures created in offshore tax havens allow foreign corporations to shift profits to tax-friendly jurisdictions. They do so by booking as little profits in the country where business activity exists and instead, transferring profits to low tax jurisdictions like Mauritius and the Cayman Islands.
So, when India tried to recover $2.1 billion in capital gains taxes from the US $11.1 billion Vodafone-Hutchison deal by plugging the loopholes in its domestic tax law (by way of retrospective tax law introduced in 2012), it was dragged before tribunals manned by private arbitrators who have been openly professing and practicing neo-liberal school of capitalism. India was forced to defend itself before such tribunals because it had signed BITs with countries like the UK and the Netherlands.
Beginning early 1990s when India started signing these BITs and DTTs, it neither had the institutional knowledge nor the capability to understand the fine print or wide-ranging revenue implications of such treaties.
It signed on the dotted lines of the existing treaty models pushed down the throat of the third world by organisations such as OECD, IMF and the World Bank.
As India opened its markets and deregulated strategic sectors such as telecommunications, insurance and oil, gas and mining, foreign multinational corporations started making investments here through post box companies floated in Mauritius, Singapore and the Cayman Islands. These offshore entities had no substance, staff, assets, office space, or business or commercial rationale other than to evade taxes in India. More than 35% of the total foreign direct investment into India between 2000 and 2015 was funnelled through Mauritius alone (more than $125 billion was invested through Mauritius). By some estimates, India has lost revenue to the tune of $10-15 billion, not just in capital gains tax, but also dividends tax, withholding tax on outflowing interest and royalty payments due to the Mauritius treaty over the last 20 years
As a result, the wealth created in India has been accumulated not in India, but outside it, in offshore financial centres and tax havens. If you are an Indian tax resident and buy a share for Rs 100 and sell it for Rs 200, you would be liable to pay capital gains tax on Rs 100 in profits. But if you are Hutchinson and make billions of dollars by setting up a telecom business in India, you get away without paying any taxes because you had used the Cayman Islands to funnel money in and out of India.
Pushback Against Tax Evasion
Vodafone and Cairn arbitral awards are a blot on the current international economic law regime.
India has for the past few years started rolling back its BITs and also amended many of its existing DTAAs. But it’s not enough. All these treaties have sunset clauses, making India liable to all existing legal disputes.
India must not only resist these on legal grounds but launch a full geopolitical offensive, demanding a rewriting of the international tax and investment laws that strike a balance between the development needs of the developing countries and the legitimate business interests of investors.
The power of the State to act in public interest and promote the welfare of its people should only be limited by the principles of the rule of law and constitutionality. India’s tax law must apply to both foreign and Indian companies.
The state’s power to architect its tax regime according to its development needs is integral to its sovereignty.
No private individual sitting in The Hague should have the power to decide who is liable to pay taxes and who is not. That job should be done only by the Indian parliament and if a dispute arises it must be adjudicated only by Indian courts.
(Ashish Khetan is an author and lawyer. He specialised in international economic law at Cambridge University. His latest book, Undercover, has just been released. The views expressed are personal.)