Vodafone Case: Perils of State Overreach

ECONOMY/ GOVERNANCE

Topic: General Studies 2, 3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development.
• Government policies and interventions for development in various sectors and issues arising out of their design and implementation

Vodafone Case: Perils of State Overreach

Context: The Vodafone Group has just won one of the most high-stakes legal battles involving a foreign investor and the Indian state under international law.

For a brief background on the issue: Click Here

Do You Know?

• 2012 Amendment of Income Tax Act: The income deemed to be accruing to non-residents, directly or indirectly, through the transfer of a capital asset situated in India is taxable retrospectively with effect from April 1, 1962.
• This amendment was carried out to override the Supreme Court ruling in favour of Vodafone. 
• The Court held that Vodafone didn’t owe any tax to the Indian state on account of Vodafone acquiring a 67% stake in Hutchison Essar through an offshore transaction.

What was the ruling?

• An Investor-State Dispute Settlement (ISDS) tribunal, constituted under the India-Netherlands bilateral investment treaty (BIT), has ruled that India’s imposition of tax liability amounting to ₹22,000 crore on Vodafone is in breach of India’s BIT obligations.

Can the government challenge the award?

• It is likely that the government might challenge the award at the seat of arbitration or resist the enforceability of this award in Indian courts alleging that it violates public policy.
• If the government indeed follows these options, there’s a long, gruelling road ahead for Vodafone. 
• The government would be ill-advised to go down this road because it would mean that India does not honour its international law obligation

Key lessons from the case

• Against the spirit of Democratic norms: Unleashing tax inspectors to extract money out of foreign investors by constantly changing the rules of the game is not an attribute that a liberal democracy should be proud of.
• Retrospective Amendment termed as Tax Terrorism: The opposition of the day vehemently criticised the retrospective amendment calling it “tax terrorism”. 
• Investor Sentiment: India should learn that being a country that values the rule of law is an important quality to win over the confidence of foreign investors and international goodwill. 
• Usage of Taxpayer’s Money: The tribunal has ordered India to reimburse legal costs to the tune of more than ₹40 crore incurred by Vodafone in fighting this case, which will come from taxpayer’s money
• Cost of non-compliance: If the order is not complied, it would send a deleterious signal to foreign investors reaffirming the sentiment that doing business in India is indeed excruciating.
• Honouring international law: All the three organs of the Indian state — Parliament, executive, and the judiciary — need to internalise India’s BIT and other international law obligations. These organs need to ensure that they exercise their public powers in a manner consistent with international law.
• Impact on other disputes: This ruling might have an impact on the two other ISDS claims that India is involved in with Cairn Energy and Vedanta on the imposition of taxes retrospectively.
• Restrain from further hardening BITs:  India unilaterally terminated almost all its BITs after foreign investors started suing India for breaching BITs. The belief in the Indian establishment is that the ISDS regime unduly intrudes into India’s sovereignty. Hence it is quite possible that India might use this award to further harden its antagonistic stand against ISDS and BITs, which should be resisted. 

Conclusion

• The case is a reminder that the ISDS regime, notwithstanding its weaknesses, can play an important role in fostering international rule of law
• If the government is serious about wooing foreign investment, India should immediately comply with the decision and repeal the retrospective provision which still remains in statute books.

Connecting the dots:

• Protectionism in economically interconnected world
• Bilateral Investment Treaties and Concerns