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Vodafone wins Indian retroactive tax dispute

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An arbitral tribunal has unanimously held that India’s imposition of a US$2.7bn tax on Vodafone, which includes more than US$1bn in interest and penalties, is contrary to India’s international law obligations under the Netherlands/India bilateral investment treaty (‘the treaty’). The tribunal, in its landmark award delivered on 25 September, has directed India to cease taking any further action with respect to the tax imposed on Vodafone.

What was the case about?

India first taxed Vodafone in 2007, following Vodafone’s US$11bn acquisition of a majority stake in Hutchison Essar, an Indian telecoms company. Although the acquisition was structured so that Vodafone’s Dutch subsidiary would acquire the single issued share in a Cayman Islands company (which indirectly held shares in Hutchison Essar), the Indian tax authorities imposed a US$2.2bn capital gains tax on the share sale by arguing, among other things, that Indian law permitted the taxation of gains on the indirect transfer of shares in an Indian company.

Vodafone challenged the tax assessment in the Indian courts and, in 2012, the Indian Supreme Court held that no capital gains tax was payable because the transaction did not result in the transfer of a capital asset in India.

Soon thereafter, India amended its Income Tax Act to clarify that transactions such as the Vodafone-Hutch transaction were taxable retroactively in India. In 2013, India issued a tax demand to Vodafone for approximately US$2bn, which was later increased to approximately US$2.7bn in 2016.

In response, Vodafone commenced arbitration under the treaty, claiming that the demand was in breach of India’s obligation to accord fair and equitable treatment (FET) to Dutch investors under the treaty.

What did the arbitral tribunal hold?

The award is not public, but the operative part of the award has been published by some sources. The tribunal held that:

  • it has jurisdiction under the treaty; 
  • Vodafone is entitled to FET in respect of its investments in India;
  • the Indian government’s conduct in respect of the imposition of tax, interest and penalties, undertaken specifically notwithstanding the Supreme Court judgment, is in breach of the FET guarantee; and
  • India should ‘cease the conduct in question’, and any failure to comply will engage its international responsibility.

India has also been directed to pay costs of £4,327,294.50 to Vodafone, representing 60% of Vodafone’s legal costs.

Immediate observations

Absent the full award, and thus based only on a reading of the operative part of the award, the tribunal’s findings remain somewhat uncertain in two respects.

First, the tribunal appears to have found that India’s conduct in respect of the imposition of tax specifically notwithstanding the Supreme Court judgment is a breach of the FET standard. It is, however, unclear whether the tribunal may also have found the retroactive tax legislation itself to be a breach of the FET standard.

Second, the tribunal has directed India to ‘cease the conduct in question’. But it remains to be seen how a breach of this direction by India would be enforced. There are two possible scenarios:

  • Vodafone could enforce the arbitral award to the extent of an Indian breach. For example, if India now enforces against Vodafone’s assets, say to the extent of US$1bn, Vodafone could immediately seek to enforce against India (on the basis of the award) to that extent; or
  • Vodafone could approach the international tribunal for an award on damages resulting from any breach.

Next steps/other retroactive tax arbitrations

The arbitral tribunal was seated in Singapore; as such, it is conceivable that India may seek to challenge the award before the Singapore courts.

Other investors, including Cairn and Vedanta, have brought similar claims against India under the India/UK bilateral investment treaty. Both these cases pertain to the same transaction, and the amounts involved are in excess of US$4bn (including interest). The arbitral awards in the Cairn and Vedanta cases are expected any day.

Key takeaways

Vodafone’s high profile award highlights the need for international investors to consider available contractual and international law protections against potentially arbitrary or unfair tax charges, especially in a divestment context. Such risk management may be undertaken as a matter of careful project structuring prior to an investment being made.

Bilateral investment treaties are an important source of protection because they enable a qualifying investor to enforce international law rights directly against a host state before an independent international arbitral tribunal. These tribunals may award significant damages where the conduct of a state is found wrongly to impair the value of an investment. 

Will Thomas, Helen Buchanan & Rohit Bhat, Freshfields Bruckhaus Deringer

Issue: 1503
Categories: In brief