Apart from asking for a $1.1-billion compensation and $5.6 billion in damages, Cairn Energy has said that the transaction on which the $5.5-billion retrospective tax is being applied was cleared by the government, and on several occasions prior to the retrospective tax being introduced in the 2012 Budget.
Cairn Energy and Cairn UK Holdings have said this in their claim before the arbitration tribunal. The Indian government has till the end of the year to respond to the claim, after which the hearings in the case will begin.
While Cairn has said that it would have done an IPO in the UK instead of in India had it known the government would apply a tax to the transaction, what is harder to ignore is its statements that the Foreign Investment Promotion Board (FIPB) — this included members from the department of revenue — cleared every leg of the transaction which involved setting up an Indian subsidiary and transferring shares.
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According to the transaction, Cairn India (CIL) would issue up to 70% of its own shares in return for 70% of the shares of Cairn India Holdings (CIHL) — a company listed in Jersey — which held the group’s assets; this was to be followed by another transaction in which CIL would purchase the remaining 10% of CIHL from Cairn UK Holdings (CUHL) for cash.
On September 21, 2006, the FIPB — FE has a copy of the approval — formally approved the transaction and its letter specifically describes the various legs of the transaction.
Even in January 2007, after Cairn India was listed — after raising $1.98 billion in the IPO — Cairn Energy’s statement to the
arbitration panel says, the government did not raise the issue of taxing an IPO.
“Because the share exchanges between CIL and CUHL were between two ‘associated enterprises’, at the request of the Income Tax Authority in the course of a tax assessment of CIL,” Cairn
Energy has stated, “the transfers were subject to special tax scrutiny by the Transfer Pricing Officer. The TPO eventually issued an order describing
those share transactions in detail and confirming that Cairn conducted them and arm’s length and in compliance with Indian tax laws.”
Cairn Energy goes on to talk of its 40% stake sale to Vedanta and how it paid $536 million in taxes on the sale. “Notably, the tax certificate issued to Cairn in connection with these sales,” the company says, “demonstrated that the Income Tax Authority had carefully scrutinised the 2006 share exchanges between CUHL and CIL to establish the base case for the purpose of determining the applicable capital gains tax rate.”
In short, Cairn concludes, “in the years after the 2006 corporate reorganisation, the precise share transfers at issue in this arbitration … were within the direct knowledge of the Income Tax Authority, which carefully reviewed them and repeatedly confirmed that they complied with Indian tax laws”.
Cairn even cites the proposed versions of the Direct Taxes Code in 2009 and 2010 that clearly show the law, as it existed then, did not envision a tax in the case of a transaction such as the Cairn one.
Cairn points out that even if you ignore the issue of its transaction not being taxable, the way the taxman calculated the notional gain is faulty. It points to the tax order saying Cairn having omitted the details of its transactions while applying to the
FIPB for clearance and says “in fact, the FIPB’s own approval letter specifically mentions this cash transaction”.
