India’s reputation among foreign investors tarnished with Vodafone tax demand; Modi must now accept reward

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September 28, 2020 9:50 AM

The Hague panel threw out Indian government’s $3 billion tax demand against Vodafone, finding it to be in breach of fair treatment under the country’s bilateral investment protection pact with the Netherlands.

Vodafone arbitration case india retrospective tax dispute

Strong states grow stronger by putting limits on their own power; weak states become weaker by descending into arbitrariness. India has to choose which it wants to be. That’s the message being given to New Delhi by an international arbitration tribunal in The Hague. The panel threw out the Indian government’s $3 billion tax demand against Vodafone Group Plc, finding it to be in breach of fair treatment under the country’s bilateral investment protection pact with the Netherlands, and awarded costs to the British telco.

This ends a decade-old saga that tarnished India’s reputation among foreign investors. Rather than appealing the decision, Prime Minister Narendra Modi’s administration should accept defeat, honor the award, and move on. While much of the blame for this mess belongs to the previous Congress Party-led coalition, Team Modi had six years to end the dispute. Ending “tax terror” was also his party’s promise in the 2014 election that brought Modi to power.

If anything, reckless expansion of the state’s power — both in the economy and broader society — has become the norm since then. One hopes that this becomes a moment when Indian politicians of all hues will come together to say, “Yes, we bungled. We should never have amended the tax law retrospectively to go after Vodafone. It cost us more in prestige than we could hope to win.”

The quarrel goes back to Vodafone’s 2007 purchase of Li Ka-shing’s India wireless business. The Hong Kong tycoon sold a Cayman Islands-based investment firm to the U.K. operator. That firm controlled, via other offshore entities, CK Hutchison Holdings Ltd.’s  67% stake in Hutchison Essar Ltd., the Indian unit. The taxman wanted a share of CK’s vast capital gains and asked Vodafone to settle the bill from the amount it had withheld from Li’s check. But Vodafone’s lawyers had advised that no tax was applicable. The dispute went to India’s Supreme Court, which held that the government’s tax jurisdiction didn’t extend to the Cayman Islands.

Then came the ugly part. The Indian government’s 2012 budget retrospectively amended the tax code, giving itself the power to go after M&A deals all the way back to 1962 if the underlying asset was in India. The vindictiveness was targeted at Vodafone, but also ensnared the U.K.’s Cairn Energy Plc, which in 2006 had transferred ownership of its Rajasthan oil field, the country’s biggest onshore discovery in two decades, to Cairn India Ltd., to prepare for the local unit’s initial public offering.

What’s worse, the $4.3 billion final assessment order for Cairn Energy came in February 2016. By that time, Modi’s government had been in power for almost two years, giving it ample time to fulfill its promise of a non-adversarial tax regime. After Cairn disputed the levy, New Delhi expropriated its shares in Indian billionaire Anil Agarwal’s Vedanta Ltd., into which Cairn had merged the India unit. The government pocketed the dividends and then sold the stock.

The application of the retrospective tax took a farcical turn when, around the Christmas holidays of 2016, a month after a draconian (and once again arbitrary) ban on 86% of the country’s banknotes, India began to instruct fund managers to withhold and pay taxes when investors made a profit selling units in offshore vehicles that had half or more of their investment in Indian securities. Thankfully, this impractical plan was dropped after it was pointed out that it would kill the India-focused funds industry.

Cairn shares closed almost 13% higher in London on Friday. The Edinburgh-based company’s arbitration award is also expected soon. Investors have reason to be hopeful after it turned out that even India’s own nominee on the Vodafone tribunal rejected New Delhi’s claim. For Vodafone’s India unit, though, the victory is Pyrrhic. It’s now the victim of a different overreach: a life-threatening $7.8 billion demand for past use of airwaves.

In a way, it’s good that data irregularities forced the World Bank to suspend its “Ease of Doing Business” survey, which saw India zoom past 79 nations between 2014 and 2019. The reality on the ground may be very different. Modi’s government didn’t invent the capricious Indian state, but it hasn’t lessened uncertainty or cut red tape. Neither for small startups, nor for large global investors. Appealing the Vodafone award will only mean that it’s once again failing to learn its lesson.

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