It may be worth checking whether the holding company of a foreign investor in India is located in a country with a bilateral investment protection treaty with India when such disputes come to the fore.

Earlier this month, Cairn Energy filed a notice for settlement of disputes with the Indian government under the Agreement for Promotion and Protection of Investments between the UK and India. The dispute stems from a tax demand of $1.6 billion raised by the Indian Income Tax Department on Cairn Energy.

The basis of the tax demand is an alleged capital gain made when Cairn Energy transferred its Indian business to a newly incorporated Indian entity in 2006 pursuant to a group reorganization. In addition, the Indian Income Tax Department has prohibited Cairn Energy from selling its residual stake of circa 10 percent in the Indian entity, whose value is said to have diminished in the period of the restriction.

Accordingly, two aspects appear to merit examination.

The Current Position of Indirect Share Transfers

  • The Indian tax law was amended in 2012 retrospectively from 1961 to provide for the taxation of indirect transfers of shares, post the landmark Supreme Court judgment in the Vodafone case in favour of the taxpayer.
  • The amended law clarified that any share or interest in a foreign company will be deemed to be situated in India if its value substantially derives, directly or indirectly, from assets located in India.
  • For historic cases that could be investigated under the retrospective provisions, this is a risk that will remain unless the government takes an in-principle decision not to invoke these provisions.
  • In the recently laid out budget, the term "substantial" is proposed to be clarified to mean cases where the value of Indian assets: (i) exceeds INR 100 million; and (ii) represents at least 50 percent of the value of all assets owned by the foreign company. The gains from indirect share transfers are proposed to be taxable in India on proportionate basis, i.e., to the extent the gains are reasonably attributable to assets located in India.
  • It is also proposed to grant exemption from taxation of capital gains arising from indirect transfers in the following scenarios:
    • Foreign entity that is transferred directly owns Indian assets—Where the transferor of shares or interest in the foreign entity (along with associated enterprises) does not have the right of control and management over the foreign entity and does not hold more than 5-percent voting power / share capital / interest in such foreign entity.
    • Foreign entity that is transferred indirectly owns Indian assets through another company—Where the transferor of shares or interest in the foreign entity (along with associated enterprises) does not have the right of control and management over the foreign entity and other company and does not hold more than 5-percent voting power / share capital / interest in the foreign entity / other company.
    • Transfer of shares or interest in a foreign company under a scheme of amalgamation or demerger, subject to conditions.

The Arbitration Option for Taxation Disputes

  • It may be worth checking whether the holding company of a foreign investor in India is located in a country with a bilateral investment protection treaty with India when such disputes come to the fore.
  • Given there has been a prior award against the Government of India of a substantial amount, it is likely that every effort will be made to resolve this matter during the mandatory six-month negotiation period.
  • Further, several other cases could end up on a similar plane, and thus, it may be prudent to review these arrangements.