Bio: Mr. Swarnendu Chatterjee is an Advocate-On-Record, Supreme Court of India, and a Senior Associate at L&L Partners, Delhi.

The series of never-ending court trials of the cases affecting the relations with foreign companies don’t seem to be ending any sooner. Every other day we witness yet another turn of events taking place in some of the other famous but old cases. The recent highlight has been the Vodafone arbitration case against the Indian government. The event traces back to 2007, when VIH i.e, Vodafone International Holdings B.V. entered into an agreement with Hutchison Telecommunications International Limited (HTIL), a foreign company, to acquire its 67% shareholding in a Cayman Island Company at $11 billion. In the process, VIH was supposed to withhold the capital gains of the HTIL, but it didn’t. The Indian revenue authorities considered that acquisition of a stake in HEL by VIHBV was liable for tax deduction at source under Section 195 of the Income Tax Act, 1961. Soon after, the Indian income tax authorities passed an order against VIH demanding payment of $2.2 billion for failure to withhold tax claiming that the subject transfer had the effect of transferring the Indian assets and therefore, such transfer was taxable in India.

In order to prevent this from happening VIHBV challenged the demand notice in Bombay High Court, which ruled in favor of the Income Tax Department. The matter further went to the Supreme Court of India, where on January 20, 2012, the Supreme Court of India discharged VIHBV of the tax liability imposed on it by the Income Tax Department of the Plaintiff. The Supreme Court held that the sale of a share in question to Vodafone did not amount to the transfer of a capital asset within the meaning of Section 2(14) of the Income Tax Act. The verdict was crestfallen for the Indian government as not only did it quashed the demand of INR 120 billion by way of capital gains tax but also directed a refund of INR 25 billion deposited by Vodafone in terms of the interim order dated November 26, 2010. Though, the victory did not last long, as under the guidance of late President Pranab Mukherjee, the Annual Finance Act of 2012 was brought in introducing inter alia for the insertion of two explanations in Section 9(1)(i) of the Income Tax Act (2012 Amendment). The first explanation clarified the meaning of the term “through”, it stated that “for the removal of doubts, it is hereby clarified that the expression ‘through’ shall mean and include and shall be deemed to have always meant and included ‘by means of’, ‘in accordance of’ or ‘by reason of’.” Now, the second explanation clarified that “an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India”. The Indian Government retrospectively amended the tax laws in India which had the effect of nullifying the basis of the decision of the Supreme Court and, renewing the tax demand on Vodafone. Obviously, then the amendment was challenged in the Permanent Court of Arbitration at Hague by invoking clause 9 of the India – Netherlands BIT through a notice of dispute dated April 17, 2012.

The clause was rebutted by the Indian government stating the amendment has no scope with India- Netherland BIT. But, PCA quashed the income tax department’s demand of Rs 22,000 crore as tax, penalty, and interest on Vodafone on the ground that India violated the bilateral investment treaty with the Netherlands by retrospectively amending the law. The award was passed in favor of VIHBV, reportedly for violation of the fair and equitable treatment standard under Article 4(1) of the India – Netherlands BIT. Tribunal directed India to reimburse legal costs of approximately INR 850 million to Vodafone.

Sources of the Ministry of Finance said that the government would seek to appeal the award before a court in Singapore-which was the location of the arbitration-after taking legal advice. Though no decision has yet been taken about the action of the Indian government, but several statements are largely being followed. One of such is of the Solicitor general Tushar Mehta, stating that an arbitral tribunal cannot render a law passed by a sovereign parliament ineffective. He said, “ the question of law is the power of arbitration tribunal to virtually and substantially declare a parliamentary legislation of a competent Parliament of a sovereign nation to be non- est and unenforceable- itself is an issue and the Union must challenge the same award.” As for sovereign powers of India to pass retrospective legislation, the Finance Minister recently commented that India has sovereign powers to amend its laws. However, these amendments are required to have a prospective effect.

The Government is considering its legal options on the failure of a high-profile international tax arbitration dispute against Vodafone, which aims to restrict damages not only in this matter but also in the dispute of related litigation against Cairn Energy. Although the financial repercussions of the case are limited to having to pay Vodafone Rs 85 crore of legal expenses, what is at stake in the government mind is a separate arbitration concerning Cairn Energy plc of the United Kingdom.

The Vodafone tax case has been hanging fire for far too long. This long delay is not in India’s interest as it seeks to attract greater investment into the country. A longer delay in the case might have its effect on other factors too, but the war between the government and VIH doesn’t seem to be ending any sooner.