Home » Between The Lines » The Permanent Court of Arbitration, Hague: The Indian Government’s imposition of tax liability along with interest and penalty on Vodafone, pursuant to a retrospective amendment made in the Income-tax Act, 1961, was in violation of the bilateral investment treaty signed between India and Netherlands

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The Permanent Court of Arbitration, Hague (“PCA”) has in its award released on September 25, 2020 (“Award”) in the matter of Vodafone International Holdings BV v. The Republic of India [PCA Case No. 2016 – 35] held that, the Indian Government’s imposition of tax liability along with interest and penalty on Vodafone International Holdings BV, Netherlands (“Vodafone”), pursuant to a retrospective amendment in the Income-tax Act, 1961 (“IT Act”), notwithstanding the Supreme Court judgement in favour of Vodafone, was in violation of Article 4(1) of the Bilateral Investment Promotion and Protection Agreement between India and Netherlands (“India-Netherlands BIPA”) signed in 1995.

A. Background:

i. Transaction in dispute and the Income-tax Department’s contentions:

In 2007, Vodafone (incorporated in Netherlands) had acquired entire share capital of CGP Investments (Holdings) Ltd. (“CGP”) ( incorporated in Cayman I s lands ) f rom Hutchinson Telecommunication International Ltd. (“Hutch”) (incorporated in Cayman Islands). CGP had a controlling interest in Hutchinson Essar Ltd. (“HEL”), an Indian company and a prominent player in the Indian telecom sector. In essence, Vodafone International indirectly acquired controlling interest in HEL.

Prima facie, since the buyer and seller were non-residents and since the capital asset (share of CGP) was situated outside India, no tax liability could have arisen in India in relation to the income (capital gain)arising pursuant to the transaction.

The Indian Revenue, however, was of the view that since the above transaction resulted in extinguishment of certain rights of Hutch in HEL and, alternatively in indirect transfer of assets in India, capital gains chargeable to tax in India arose, and Vodafone was thus under an obligation to withhold tax at source while making the payment of the sale consideration, in terms of Section 195 of the IT Act.

ii. Vodafone’s writ petition before the Bombay High Court:

Vodafone filed a writ petition before the Hon’ble Bombay High Court (“BHC”) challenging the action of the Income-tax Department. However, the BHC ruled in favour of the Income-tax Department*1, against which Vodafone preferred an appeal to the Supreme Court of India (“SC”).

iii. Vodafone’s appeal before the Supreme Court:

The SC by its decision dated January 20, 2012 decided the matter in favour of Vodafone and held that offshore transaction of acquisition of shares was a bonafide, structured Foreign Direct Investment (“FDI”) in India which fell outside India’s Revenue’s territorial tax jurisdiction and hence was not taxable. Accordingly, it was held that Vodafone was not liable to withhold tax under Section 195 of the IT Act and the tax demand was quashed*2.

iv. Retrospective amendment to nullify the Supreme Court judgement:

To neutralize/ nullify the effect of the aforesaid judgement of the SC, the Indian Parliament, vide the Finance Act, 2012, made retrospective amendments to various provisions of the IT Act including Section 9(1)(i) of the IT Act, which in turn, empowered the Income-tax Department to tax such indirect transfers of shares, including the aforesaid transaction.

B. Vodafone’s resort to arbitration under the India-Netherlands BIPA:

Being aggrieved by the retrospective amendments to the IT Act, Vodafone served a notice of dispute to the Indian Government on April 07, 2012, and invoked the arbitration pursuant to the provisions of the India-Netherlands BIPA.

The India-Netherlands BIPA was signed on November 06, 1995, enforced on December 05, 1996 and terminated on 3 September 22, 2016*3. Its aim was to extend and intensify the economic relations, promotion and protection of crossborder investment of the companies, and reciprocal protection of investments along with fair and equitable treatment to be accorded to the investors of one contracting party in the territory of other. While the government was continuing to oppose the arbitration, Vodafone’s parent company, Vodafone Group Plc (United Kingdom) served another notice of dispute and notice of arbitration upon the Indian Government under the Bilateral Investment Promotion and Protection Agreement between India and United Kingdom (“India–United Kingdom BIPA”). The Vodafone group contended that it intends to obtain at least one route to an arbitral forum.

The Indian Government challenged the second notices of dispute and arbitration through a civil suit before the Hon’ble Delhi High Court on account of abuse of arbitral process. However, the Hon’ble Delhi High Court finally 4 dismissed the suit*4, basis the interpretations of the BIPAs and on consideration of Vodafone’s intention to consolidate the arbitrations thus negating the possibility of multiple proceedings.

Under the India-Netherlands BIPA, the investment dispute was referred to a three-member arbitral tribunal to resolve the dispute as per Article 9(3)(c) read with Article 9(4) of the India-Netherlands BIPA and in accordance with the Arbitration Rules of the United Nations Commission on International Trade Law, 1976.

C. Order of the PCA in the arbitration proceedings under the India-Netherlands BIPA:

Reportedly*5, the PCA in its order dated September 25, 2020 held that the imposition of tax along with interest and penalties by the Indian Government, notwithstanding the Supreme Court judgement, was in breach of the guarantee of fair and equitable treatment laid down in Article 4(1) of the India-Netherlands BIPA.

The PCA noted that under the terms of India-Netherlands BIPA, it had jurisdiction to consider Vodafone’s claim for breach of the India-Netherlands BIPA. It also observed that any failure by the Indian Government to comply with the directive will engage India’s international responsibility.

Consequently, PCA ordered the Indian Government, inter alia, to reimburse to Vodafone a sum of approximately INR 850 million (£ 4.32 million).

If at all the complete order of the PCA is released in public domain, it would be interesting to note:

  • On what reasoning did the PCA overcome the jurisdictional challenge raised by the Indian Government regarding inapplicability of Article 4(1) of the India-Netherlands BIPA on tax disputes (in view of the bar prescribed under Article 4(4) of the India-Netherlands BIPA)?
  • How the term “fair and equitable” has been interpreted by the PCA to hold that the conduct of the Indian Government breached Article 4(1) of the India-Netherlands BIPA?
  • In the decision paragraph of the order, the PCA has noted that the conduct of the Indian Government in respect of imposition of tax liability on Vodafone, notwithstanding the Supreme Court judgement, is in breach of Article 4(1)of the India-Netherlands BIPA. Whether a retrospective amendment in general, when it does not nullify any judgement of the Supreme Court, would also be treated as a breach of the guarantee of “fair and equitable” treatment?

D. Recourse available to the Indian Government

Vide press release dated September 25, 2020, the Central Board of Direct Taxes (“CBDT”) has stated that the Indian Government would be studying the award and thereafter, would take a decision on further course of action including legal remedies before appropriate fora. Few developments also suggest that the High Court of Delhi has also asked the Indian Government to inform whether it wants to abide by or challenge the arbitral award.

Vaish Associates Advocates View:

Although the award is not binding on third parties, it may have a persuasive value in similar arbitrations instituted or to be instituted by other assessees. If the decision of the Tribunal renders any findings on the legality of retrospective amendments qua the fair and equitable treatment clause in bilateral treaties, then it is to be seen whether the said conclusions can have far reaching impacts on other assessees.

Additionally, the power to levy taxes has been universally acknowledged as an essential attribute of sovereignty. However, imposing taxes retrospectively does deter and discourage investor sentiments and creates unforeseen liability for assessee. If the Indian Government decides to accept the award, it may probably encourage fresh investments and renewed trust into India, more so at a time when the global geopolitical relationship with China is undergoing a rapid and perhaps permanent transformation.

For more information please write to Mr. Bomi Daruwala at [email protected]


*1 Vodafone International Holdings B.V. v. Union of India: (2010) 329 ITR 126 (Bombay)
*2 Vodafone International Holdings B.V. v. Union of India: (2012) 341 ITR 1 (SC)
*3 As per information available on the website of the Department of Economic Affairs, Ministry of Finance at https://www.dea.gov.in/bipa
*4 Union of India v. Vodafone Group Plc United Kingdom and Another: CS (OS) 383/2017 & I.A.No. 9460/2017
*5 As on date, the complete order of PCA in this case is not available in public domain. Only an extract comprising paragraph“XIV. Decision” has been reported by a media platform.