IISD | 23 March 2021
UNCITRAL tribunal finds India in breach of India–UK BIT in proceedings brought by Cairn entities
by Trishna Menon
Cairn v. India Cairn Energy PLC and Cairn UK Holdings Limited v. The Republic of India, PCA Case No. 2016-7
A PCA tribunal dismissed India’s jurisdictional objections and found it in breach of the FET standard in the India–UK BIT in an arbitration under UNCITRAL rules initiated by Cairn Energy PLC (Cairn Energy) and Cairn UK Holdings Limited (CUHL) (together, Cairn). The award was rendered on December 21, 2020.
Background and claims
The main subject of the claims was a series of transactions that took place among the Cairn group in 2006 (2006 Transactions), which reorganized the group’s Indian assets. As part of these transactions, Cairn Energy consolidated all the group’s Indian assets in 9 UK subsidiaries (9 Subsidiaries) and then incorporated CUHL in the UK and transferred its shares in the 9 Subsidiaries to CUHL, in consideration for CUHL shares. CUHL then incorporated Cairn India Holdings Limited (CIHL) in Jersey and transferred its shares in the 9 Subsidiaries to CIHL, in consideration for CIHL shares. The final step in the reorganization was the transfer of all of the Indian assets of the Cairn group to Cairn India Limited (CIL), the Indian subsidiary, by transferring CIHL from CUHL to CIL in a series of incremental stages (CIHL Acquisition).
Section 9(1)(i) of India’s Income Tax Act, 1961 (ITA), which was at issue in the dispute, according to Cairn, did not tax indirect transfers of capital assets situated in India. However, a year later, India’s Income Tax Department (ITD) attempted to change the settled interpretation of Section 9(1)(i) by seeking to impose capital gains tax on an indirect transfer by a non-resident in the Hutchison–Vodafone transaction. This attempt to “reinterpret” Section 9(1)(i) was rejected by the Supreme Court, in January 2012, in Vodafone International Holdings BV v. Union of India & Anr. (Vodafone). A few months later, the Indian Parliament enacted an amendment to Section 9(1)(i) (2012 Amendment), which effectively overturned Vodafone, and amended Section 9(1)(i), according to Cairn, with retroactive effect, to cover indirect transfers by non-residents.
In 2014, the ITD notified CUHL that it had failed to report capital gains taxable in India arising from the CIHL Acquisition and issued an order attaching CUHL’s equity shares in CIL, followed by an assessment procedure that culminated with a Final Assessment Order (FAO) in January 2016, and a Notice of Demand for capital gains tax of USD 1.6 billion, which, along with interest and penalties, amounted to approximately USD 4.4 billion (as of the date of Cairn’s claim). Cairn claimed that, since then, India forcibly sold approximately 99% of CUHL’s shares in CIL, and refused to allow CIL to distribute dividends to CUHL.
Cairn initiated arbitration, claiming that a series of measures imposed by India in relation to the 2006 transactions breached India’s obligations under the India–UK BIT, and sought full compensation for the losses flowing from those breaches. Specifically, Cairn claimed that India (i) failed to “create favourable conditions” for its investment and to accord Cairn and its investment FET, (ii) failed to accord its investments FET in violation of Article 3(2) of the BIT, (iii) unlawfully expropriated CUHL’s investment in CIL without providing fair and equitable compensation, and subjected Cairn’s investment to measures having an effect equivalent to expropriation, and (iv) violated Cairn’s right under Article 7 of the BIT to “the unrestricted transfer of their investments and returns” by depriving CUHL of the ability to sell its remaining CIL shares and to repatriate the proceeds, as well as the dividends that accrued in respect of these shares.
Tribunal dismisses India’s objections to jurisdiction and admissibility
India raised a number of objections to the tribunal’s jurisdiction, which were dismissed. India argued that Cairn’s Indian assets did not qualify as an “investment” under the BIT, firstly, because CUHL’s purported investment was not made in accordance with Indian law since the 2006 transactions were an abusive tax-avoidance scheme in violation of then-applicable laws. India did not dispute the fact that Cairn Energy made an investment in India in 1996 by acquiring an Australian company that held interests in a 1994 production-sharing contract in an Indian oil and gas field and subsequently various other assets, including production-sharing contracts and joint operating agreements. India did not allege that any of these acquisitive transactions were unlawful. The tribunal held that this arbitration related to this lawful investment, and this finding sufficed to conclude that the dispute fell within the tribunal’s jurisdiction.
The tribunal rejected India’s argument that the investment be considered in parts, with CUHL only acquiring its assets during the 2006 transactions, in accordance with the principle that jurisdictional inquiry as to whether a dispute relates to an investment should proceed by looking at the investment as a whole. Since Cairn’s claims related to Cairn Energy’s original investment, which has merely changed form over time, these claims fell within the tribunal’s subject-matter jurisdiction.
Secondly, India contended that the BIT’s definition of investment in Article 1(b) did not include indirect investments, and, as such, Cairn Energy’s assets in India were not protected under the BIT. India relied on Article 5(3), which guaranteed compensation for expropriation for the shareholders of the expropriated company, arguing that this provision would be rendered superfluous if indirect investments were in any event protected under the BIT, and relied on RosInvest v. Russia which considered a similar provision. The tribunal, however, explained that the RosInvest tribunal did not suggest that the presence of such a provision in a BIT negated the existing right for shareholders to claim for their indirect loss and concluded that the context of the BIT, as reflected in its other provisions, did not suggest excluding indirect investments from its scope of application.
India made several additional jurisdictional objections. These included that Cairn’s claims fell outside the scope of the tribunal’s jurisdiction under BIT Article 9 because it concerned “returns” and not “investments,” (ii) tax disputes could not be resolved by arbitration under the BIT due to an implied exception to its scope of application, and due to the fact that India and the UK have specifically agreed that tax disputes should be settled in accordance with the procedure prescribed in contemporaneous double taxation avoidance agreements. India also contended that taxation disputes were not arbitrable, either as a matter of international public policy, Indian law, or Dutch law (as the seat of the arbitration was the Hague). These arguments were also dismissed by the tribunal.
Violation of the FET standard found; other claims dismissed
Cairn argued that India’s fiscal measures amounted to treatment that was unfair and inequitable under the BIT. The tribunal concluded that the tax assessment was based exclusively on Section 9(1)(i) of the ITA, as modified by the 2012 Amendment. With respect to the effect of the 2012 Amendment, the tribunal stated that the fact that Parliament labelled the amendment of Section 9(1)(i) a “clarification” was not dispositive of the international legal effect of the amendment. The tribunal also concluded, based on its consideration of a wide range of evidence, that the 2012 Amendment substantively changed the scope or operation of Section 9(1)(i) and was thus not a true clarification, as India had argued. The 2012 Amendment purported to amend the content of Section 9(1)(i) from the date of enactment of the ITA (i.e., April 1, 1962). The mere fact that tax authorities were, in practice, precluded from levying taxes beyond the limitation period of six years did not change the period of retroactivity for which the 2012 Amendment purported to apply.
India argued that the 2006 transactions would have been taxable even without the 2012 Amendment because they were tax-avoidant transactions and were therefore taxable under the “look at” doctrine developed by Indian courts which focused on “substance over form.” India also argued that the 2006 transactions were taxable irrespective of the 2012 Amendment because they involved the indirect transfer of immovable property and as such were taxable under Section 2(47)(vi) of the ITA. However, the tribunal found that India had failed to establish both these defences.
After this, the tribunal considered the question of whether retroactive taxation breached the FET standard. The tribunal stated that it would carry out a balancing exercise between India’s public policy objectives and Cairn’s interest in benefiting from the values of legal certainty and predictability. In order to achieve this balance, the specific reasons given to justify the retroactive application of tax measures would be assessed. Because India did not have a specific public purpose to justify applying the 2012 Amendment to past transactions, retroactive application of the 2012 amendment to the CIHL Acquisition failed to adequately balance Cairn’s protected interest in legal certainty and India’s power to regulate. By retroactively applying a new tax burden on a transaction that was not taxable at the time it was carried out, Cairn was deprived of their ability to consider the legal consequences of their conduct, violating the principle of legal certainty, which, according to the tribunal, was one of the core elements of the FET standard. Consequently, the tribunal concluded that India breached the FET standard in the BIT.
The tribunal decided that it did not need to address Cairn’s remaining claims related to BIT Articles 3(1), 5, and 7. Since Cairn had requested the same reliefs for all these claims, even if the tribunal were to find merit in these claims, this would not affect its assessment of the appropriate reparation.
Having found that India breached the FET standard in the BIT, the tribunal stated that it must then award relief that would “wipe out” the consequences of India’s breach of the BIT and place Cairn in the position it would have been had that breach not been committed. This would involve comparing what happened in reality with the situation which would, in all probability, have existed if that act had not been committed (But-For Scenario). The difference between both would be the measure of Cairn’s damages. Being satisfied that its jurisdiction to resolve the present dispute included the power to order India, as a measure of restitution, to withdraw its internationally unlawful tax demand, the tribunal declared that the tax demand against Cairn as set forth in the FAO was inconsistent with the BIT, and Cairn was relieved from any obligation to pay it. The tribunal also ordered India to withdraw the FAO permanently and refrain from seeking to recover the alleged tax liability or any interest and/or penalties arising from it.
The tribunal also allowed Cairn’s claim for compensation for the value of the CIL shares that India seized and sold in enforcement of its unlawful tax demand under the FAO. Cairn was awarded compensation for the value of the CIL shares at the amount of net proceeds that Cairn would have received from the sale of CIL shares in the But-For Scenario. Cairn also claimed compensation for corporation tax that they would allegedly have to pay in the UK on the amount awarded by the tribunal, at the 19% corporate rate, but the tribunal found that it had not established with a sufficient degree of certainty that it was likely to incur the UK corporation tax on the totality of the amount awarded for the proceeds of the CIL shares. Consequently, it dismissed this claim.
Decision and costs
The tribunal held that it had jurisdiction over the dispute and that Cairn’s claims were admissible. The tribunal found that India had failed to uphold its obligations under the UK–India BIT and international law, in particular, that it breached the FET standard under BIT Article 3(2). It made no declaration on any of the other issues in respect of which Cairn had requested relief.
India was directed to compensate Cairn for the total harm suffered by Cairn as a result of its breaches of the treaty, by an amount of approximately USD 1,232,820,143 along with interest at a rate of USD 6-month LIBOR plus a 6-month margin of 1.375%, compounded semi-annually. The tribunal also directed India to pay around USD 22,395,114 toward Cairn’s costs of arbitration and legal representation.
Note: The tribunal was composed of Laurent Lévy (president, Brazilian and Swiss national), Stanimir A. Alexandrov (claimant’s appointee, Bulgarian national) and J. Christopher Thomas QC (respondent’s appointee, Canadian national). The award is available at https://www.iareporter.com/articles/a-1-2-billion-dollar-loss-for-india-as-cairn-energy-prevails-in-new-investment-treaty-award/.
Trishna Menon is a Senior Research Fellow at the Centre for Trade and Investment Law, New Delhi, India.