The government is weighing its legal options after losing the high-profile international tax arbitration case against Vodafone as it looks to limit damages not just in this matter but also in case of a separate lawsuit with Cairn Energy goes against it.
Last month, an international arbitration court ruled that the Indian government seeking Rs 22,100 crore in taxes from telecom giant Vodafone using retrospective legislation was in "breach of the guarantee of fair and equitable treatment" guaranteed under the bilateral investment protection pact between India and the Netherlands.
Finance Ministry sources said the government will decide on challenging the award before a court in Singapore - which was the seat of the arbitration, after taking legal opinion.
While the cost implication in the case is limited to having to pay Rs 85 crore to Vodafone in legal cost, what is weighing on the government mind is a separate arbitration involving UK's Cairn Energy plc.
If a separate arbitration panel were to hold a demand for Rs 10,247 crore in taxes using the same retrospective legislation as illegal, the government will have to pay Cairn as much as USD 1.5 billion (Rs 11,000 crore).
This is the amount equivalent to the value of shares of Cairn that the government had sold to recover a part of the tax demand. It also includes the dividends and tax refund seized.
Sources said Vodafone International Holding (a Netherland company) had in February 2007 bought 100 per cent shares of Cayman Island-based company CGP Investments for USD 11.1 billion to indirectly get 67 per cent control of Hutchison Essar Ltd - an Indian company.
The Tax Department felt the deal was designed to avoid capital gain tax in India and so imposed a tax demand, which was rejected by the Supreme Court in 2012.
To stop abuse and plug the loophole of such indirect transfer of Indian assets, the government in 2012 amended the law to make such transfers taxable in India, they said adding Vodafone was slapped with a fresh demand which the firm contested through international arbitration.
The tax demand on Cairn Energy, they said, is different as it pertains to alleged capital gains the firm made on transfer of Indian assets to a new company and listing it on bourses.
Dheeraj Nair, Partner, J Sagar Associates, said the government "should challenge the (Vodafone) award since this award will have persuasive value in other treaty arbitrations which concern the retrospective tax measures".
"Any party dissatisfied with the award has a right to challenge it, therefore such challenge is justified," he said.
Sonam Chandwani, Managing Partner at KS Legal & Associates, however, said "as the Permanent Court of Arbitration situated in The Hague had passed the award in favour of Vodafone, there lies no further authority for putting up appeal".
"The government can only go back to the Permanent Court of Arbitration on some technical point, but that will not serve any purpose," she said.
Since the Indian Arbitration Act obliges the government to implement a foreign tribunal award, Vodafone can ask for the same in case the award was challenged in Indian courts, she said.
"However, in the present scenario, since all the property, both tangible and non-tangible of Vodafone, lies outside India it will be difficult for the government to procure the same," she said.
She said in the case of Cairn Energy, India in order to procure the retrospective taxes has already expropriated all their investment.
"In circumstances such as when the Permanent Court of Arbitration gives a decree in favour of Cairn, the government of India still has the option to procure the desired retrospective taxes via grounds such that taxation is not covered under any bilateral investment protection treaty and as such cannot be arbitrated. It is challenging the jurisdiction of such panels to adjudicate on a tax matter," she said.
Nair said the government certainly has the option not to appeal in Vodafone but do so in the case of Cairn as each case is independent and brought under a different treaty, which gives different protections.
Cairn's claim is under the India-UK treaty whereas Vodafone's claim was under the India-Netherlands treaty.
While Nair said there would not be any additional negative impact on investor sentiment as they recognise that challenge proceedings are part of the norm, Chandwani said appealing against an international arbitration award will disincentivise the investors.
"Any investor will start contemplating on investing in such countries as any dispute arises the government of such countries might not comply with the international order, putting the investors to losses. It creates hindrance in the ease of doing business in such countries and thus discourage them to make any investments to indulge in any form of funding," she said.