The Cairn arbitration award demolishes almost all the arguments that the taxman has made, or can make
The structuring is a complex one and involved Cairn Energy transferring its India assets such as the Rajasthan fields to Cairn India from various offshore subsidiaries that held them till then.
Even though the government has said it will challenge the Cairn Energy arbitration award, what the grounds of the appeal will be is not immediately clear. Some newspaper reports suggest one line of appeal could be that Cairn structured the deal in such a way as to avoid paying tax, and that is not allowed under the law; indeed, that argument is also in keeping with the other argument made by the Indian taxman, that irrespective of the UPA’s retrospective tax amendment, the Cairn transaction was always taxable due to its tax-avoidant nature.
Whether that will work or not is unclear, but it would be a good idea to get an independent group of tax experts to study the arbitration award since it seems to have debunked many of the arguments made by the Indian side including the ones on the retrospective tax being merely a clarification of the existing law, of even the pre-retro-tax law allowing the taxman to charge taxes on overseas sales where the underlying asset is in India, of the Cairn transaction being structured in such a way as to avoid taxes, etc.
The arbitration panel doesn’t get into the taxman’s calculations of the capital gains made by Cairn but it does record that the taxman focused on just one leg of the transaction, and it also points out that if Cairn did not pay capital gains tax in the UK, that is the UK government’s policy choice, not because the deal was structured to be tax-avoidant.
Indeed, as part of its attempt to successfully challenge the Cairn award, the taxman will have to explain why, for instance, when there were four occasions – over a period of several years – on which the Cairn deal was examined by the government, there was no attempt to slap a tax on it. Prior to the 2006 deal, for instance, the restructuring – where Cairn’s overseas subsidiaries that owned the Indian assets got transferred to Cairn India – needed the approval of the Foreign Investment Promotion Board (FIPB) that is led by the finance ministry; the structure of the deal was also presented to Sebi though it can be argued that examining the tax implications is not Sebi’s job.
Since the structuring of the deal between various Cairn Energy subsidiaries needed to be fair, it was also examined by transfer pricing officers of the revenue department. Even this did not result in anyone suggesting that a capital gains tax had to be paid.
A few years later, in 2009, Cairn sold 2.3% of its shares in the Indian operations to Petronas and, in 2010, it a controlling stake to Vedanta. Once again, the original restructuring was looked at to determine the acquisition cost for calculating the capital gains; in neither case did the taxman ever say a tax was due on the 2006 IPO process. Indeed, since Cairn filed a case against the taxman on being charged a higher rate of tax in the Petronas sale, it was also examined by the court; Cairn won the case – its dues, though, were confiscated by the taxman!– and, no, the issue of a tax on the 2006 IPO was never brought up by even the taxman during the case.
Interestingly, while Cairn lost the case against the taxman at the Income Tax Appellate Tribunal (ITAT) in 2017, the tribunal said Cairn “could not have visualize[d] its liability for payment of advance in the year of transaction therefore, there cannot be any interest payable by the assessee u/s 234A and 234B of the Act….” In other words, the taxman was quite wrong when he told the arbitration panel that, even if the retrospective tax had not been brought in, the transaction would have been eligible for taxation as it was aimed at tax avoidance.
As it happens, despite the taxman arguing this, it could not provide one instance of it taxing deals like the Cairn one till the retrospective tax came in. Indeed, when Cairn first came into India in 1996 when it bought Command Petroleum’s interest in Ravva, it also involved offshore structures but no tax was paid at that time either. And while the taxman argued the retrospective tax was not a new tax but was really just clarifying or reiterating the stated position, the Arbitration award cited many reports from various panels, and even quoted then finance minister Pranab Mukherji to show that this was really a new tax.
Though the Arbitration panel ruled that levying capital gains tax on Cairn’s IPO process violated India’s obligations under the bilateral investment treaty, it nonetheless examined it; and just as well since India is now arguing the tax was justifiable as Cairn had structured the deal in a way as to avoid paying taxes.
The structuring is a complex one and involved Cairn Energy transferring its India assets such as the Rajasthan fields to Cairn India from various offshore subsidiaries that held them till then. Rather than getting into the details of each leg of the transaction involving various holding companies in different tax jurisdictions, a simple way to understand this is to consider the fact that Cairn Energy owned Indian assets – valued by Rothschild during the IPO process at $6-7.5bn – and it transferred these to Cairn India which did an IPO based on these assets for roughly this valuation. So there was, in fact, no capital gains that could be taxed in India.
And how ridiculous the taxman’s demand was is best brought out by the fact that while Cairn India raised under $2bn through the IPO, the tax Cairn Energy was asked to pay was $1.4bn! Indeed, had Cairn Energy wanted to lower its tax burden, all it needed to do was to wait – for a year after Cairn India’s IPO – to sell its shares in Cairn India so as to qualify for the lower long-term tax. Also, if tax avoidance was the plan, Cairn could have structured its sales to Petronas and later Vedanta to also avoid paying taxes; indeed, it could have sold its shares on the floor of the stock market and then paid just the securities transaction tax since there was no capital gains applicable to such sales till a few years ago.
Given the arbitration panel’s rulings on so many issues raised by the taxman, finance minister Nirmala Sitharaman’s best bet is to seek the opinion of independent experts on whether India can even win an appeal. After all, the country doesn’t want to cut a sorry figure the second time around.