Cairn Energy is set to approach the International Court of Justice (ICJ) on September 11, asking it to appoint an arbitrator on behalf of the Indian government in its $1.6 bn – plus interest and penalties – pending tax case relating to its IPO in October 2006. While Cairn had appointed former Bulgarian minister and lawyer Stanimir Alexandrov – he is associated with a Washington-based law firm – as its arbitrator in April, the government has yet to appoint an arbitrator under the Notice of Dispute filed on March 11.
As per the terms, if an arbitrator is not appointed within 6 months, the other party can approach the ICJ. Once the two arbitrators have been appointed, they will appoint an umpire arbitrator.
The government’s first response, in May, to Cairn’s Notice of Dispute was ‘it is the consistent position of India that tax proceedings are not covered by the Bilateral Investment Promotion and Protection Agreements and hence dispute cannot be resolved by arbitration’. When Cairn insisted it could, the government’s next letter said ‘Arbitration cannot be invoked prior to the expiry of six months from the date on which the Notice of Dispute is made’.
Cairn Energy’s former subsidiary – Cairn India – in which it had invested $5 billion over two decades prior to its sale, today produces nearly a third of India’s crude oil production. Cairn India, which has also been served a tax notice in the same case, is already in court in appeal.
The Cairn Energy case does not pertain to the sale of its Indian subsidiary to Anil Agarwal’s Vedanta Group in 2011 — all taxes were paid on the $8.7 billion deal — but to its IPO in 2006 (see graphic).
At the time of the IPO, Cairn India was an empty shell of a company and all Cairn Energy’s Indian assets were held by its overseas subsidiaries. Since the idea was to create one big energy powerhouse, Cairn Energy took all the assets from various overseas subsidiaries and housed them in its wholly-owned Indian subsidiary Cairn India. As all firms were owned by Cairn Energy, there was no cash outflow from India.
The re-organisation was approved by the RBI, the Foreign Investment Promotion Board and Sebi. Cairn Energy’s argument is that since there was no transfer of shares in 2006, no capital gains were made and no tax was applicable. Once the retrospective tax law was brought in, however, the taxman decided to open up the IPO case.
Cairn Energy’s notice, under the UK-India Investment Treaty, says that under Article 3, India was obliged to “create favourable conditions”, and ensure “fair and equitable treatment” and “full protection and security” for Cairn’s investments – this, Cairn argues, was violated by the retrospective tax. Under Article 5, Cairn says, India was obligated not to expropriate Cairn’s investments, but it did so by attaching Cairn Energy’s shares in Cairn India.
Since the value of the Cairn India shares has fallen by over 40% from the $1bn at the time they were attached, Cairn Energy has also sought damages – according to the company, the income tax notice resulted in an immediate drop in its share price by 43% and caused Cairn significant reputational harm; the inability to realize the value of the shares also prevented it from making other investments.