Whether to challenge or not

21/Oct/2020, 11:14 AM, Authored by Hiroo Advani & Tariq Khan

Implications of the Vodafone Case on Foreign Investments

Finally, a decade old dispute between the Vodafone Group and India has come to an end. The Permanent Court of Arbitration has unanimously decided against India’s retrospective demand of Rs 22,100 crore in an arbitration initiated under the India-Netherlands Bilateral Investment Treaty (BIT) and held that Vodafone is entitled to fair and equitable treatment under the BIT. The arbitral award is not out in the public domain however, this article gives a brief history of this interesting tax dispute and discusses the probable implications of the Vodafone ruling on foreign investments in India.

In May, 2007 Vodafone purchased a 67% stake in Hutchison Essar Limited for $11 billion. Subsequently, in September, 2007, the Indian government sent a demand to Vodafone of Rs 7,990 crore as capital gains tax and stated that Vodafone should have deducted the tax at source before making any payments to Hutchison. The said show cause notice was challenged in a writ petition before the Bombay High Court by Vodafone wherein it was contended that there is no tax liability on capital gains as the transaction did not include transfer of any capital asset situated in India. As per the Indian tax authorities, the purpose of such a transaction was acquisition of 67% controlling interest in Hutchison. Therefore, the tax department sought capital gains tax from Vodafone that were arising from share capital sale of CGP on the ground that CGP held the Indian assets even though it is not an Indian tax resident. The said petition was dismissed by the Hon’ble Bombay High Court.

Decision of the Supreme Court

Vodafone approached the Supreme Court against the decision of the High Court and the Supreme Court decided the issue in favour of Vodafone and held as under:

Applying the look at test in order to ascertain the true nature and character of the transaction, we hold, that the Offshore Transaction herein is a bonafide structured FDI investment into India which fell outside India’s territorial tax jurisdiction, hence not taxable. The said Offshore Transaction evidences participative investment and not a sham or tax avoidant preordained transaction. The said Offshore Transaction was between HTIL (a Cayman Islands company) and VIH (a company incorporated in Netherlands). The subject matter of the Transaction was the transfer of the CGP (a company incorporated in Cayman Islands). Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax the said Offshore Transaction.

The judgment passed by the Supreme Court in 2012 provided clarity on the issue of tax evasion vs tax avoidance. Also, the judgment gave a positive message to the international community that India is accepting foreign investments as long as it is done honestly. The Supreme Court realised the importance of foreign direct investment in India and gave clarity to the law.

Retrospective Taxation

The dispute between  became a ‘retrospective taxation case’ when in 2012 Finance Minister Late Pranab Mukherjee proposed an amendment to the Finance Act, which gave the Income Tax Department the power to retrospectively tax companies on certain products and items or services which previously companies have taken advantage of. Generally, when the Supreme Court gives its decision on a particular issue, the same attains finality and is not open for challenge. However, the government circumvented the decision of SC by bringing an amendment to the Finance Act, thereby applying retrospective taxation. As a result, the tax liability was restored and the onus to pay the taxes fell back on Vodafone.

Invocation of BIT

Thereafter, negotiations took place between the parties. However, in 2014 the negotiations failed and Vodafone invoked Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995 and turned this into an inter-country dispute.

Vodafone contended that the imposition of tax by the Indian government by way of a retrospective amendment is a violation of fair and equitable treatment (FET) promised under the India-Netherlands BIT. Vodafone relied on Article 4.1 of the India-Netherlands BIT as per which the investors shall at all times be given fair and equitable treatment, which also includes an obligation to ensure a stable and predictable regulatory environment.

India’s fundamental opposition throughout the arbitration was based on its premise that “disputes relating wholly or mainly to taxation are excluded from the scope of the India-Netherlands BIT”. However, this opposition clearly didn’t resonate with the Tribunal. The Permanent Court of Arbitration at the Hague, after eight years, passed an Award in the matter and gave a ruling in favour of Vodafone.

The Award

The arbitral award rendered in this case finds the Indian Government in  violation of the Fair and Equitable Treatment principle under article 4(1) of the India- Netherlands BIT. Further, it has been held that the India’s conduct of imposing tax liability of Rs. 40,000 crore on Vodafone, despite the Apex Court’s verdict, was in violation of the terms of the BIT. Relevant excerpt from the Award is as follows:

“The Respondent’s conduct in respect of the imposition on the Claimant of an asserted liability to tax notwithstanding the Supreme Court Judgment is in breach of the guarantee of fair and equitable treatment laid down in Article 4(1) of the Agreement, as is the imposition of interest on the sums in question and the imposition of penalties for non-payment of the sums in question.”

The Indian government has also been directed to pay around Rs. 40 Crore as partial compensation for the legal cost. The said finding of the Tribunal is as follows:

 “The Respondent will reimburse to the Claimant the sum of £ 4,327,294.50 or its equivalent is US Dollars, being 60% of the Claimant’s costs for legal representation and assistance, and € 3,000 or its equivalent in US dollars, being 50% of the fees paid by the Claimant to the appointing authority.”

However, the Indian Government can still approach the High Court of Singapore requesting it to set aside the arbitral award, given that the seat of arbitration was in Singapore.

Foreign Direct Investment in India

As the Indian government has a vision of an Atmanirbhar India, India has issued a call for foreign investors to enter India and, indeed, India has reached from 142 (in 2014) to 63 (in 2020) in the World Bank’s ‘Ease of Doing Business’ in ranking by becoming top 10 destinations for FDI in the last six years. However, India in its 2016 Model BIT has faced fair amount of criticism for replacement of the ‘Fair and Equitable Treatment’ clause with ‘Treatment of Investments’ clause that states “neither party shall subject investments to measures that are manifestly abusive, against norms of customary international law and to un-remedied and egregious violation of due process.”

Whether India should appeal against Vodafone PCA Award?

Recently, a story was published by Business Standard stating that the Attorney General KK Venugopal had informally conveyed his opinion to the government that India should not be filing an appeal against the PCA award in the Vodafone case. Subsequently, on 15.10.2020 the Ministry of Finance issued the following clarification on appeal against the decision in Vodafone case:

“A speculative news story being circulated in some section of media claiming that Attorney General has given opinion in favour of not appealing in the Vodafone Arbitration award is totally incorrect and without any factual basis. Award along with all options are under examination within the Ministry and further course of action will be decided based on such examination.”

In our view, India should not challenge the Award in view of fact that the Supreme Court had already decided the issue way back in 2012. Further, there are very thin chances of succeeding in the Appeal against the PCA Award considering the fact that Singapore has not entertained similar challenges in the past.

The Indian government must realise that the idea is to promote investment and not to create an unstable and unpredictable business environment. Therefore, this is an opportunity to give a positive message to the international community that the government will respect the arbitral Awards and will enforce them. Incidentally, there is a practice in public sector undertakings to challenge every Award which is against them. This tradition must go and the government, by not challenging this decision, will in fact encourage other PSUs also to not challenge reasoned Awards which will eventually gain confidence of the investors to invest in India.


The judgment delivered by PCA will definitely have a material bearing on similar cases wherein such issues are involved and taxation of foreign institutional investors (FII) will be impacted as a result of the Vodafone verdict. India is involved in over a dozen similar cases where retrospective tax claims and cancellation of contracts are in question and this ruling will also affect those cases where the tax demand of India is legitimate. One may also argue that the ruling of PCA is a huge loss for India as it involved a substantial issue of foreign investors meeting their tax obligations. Once the Award is out in the public, we need to take a hard look at how this decision will impact the foreign investment in the country.

Investors are still confused as to whether India is arbitration friendly or not. Between 2016 and 2017, India terminated as many as 58 bilateral investment treaties (BITs), including 22 European Union countries. Though the investment made under those treaties were protected under the “sunset” clause but this action of the government sent a mixed message to all investors. The PCA award further makes it unlikely that India shall delve in an investor friendly BIT in the near future. Repeatedly losing cases on an international level including the White Industries case, the Antrix case and now the Vodafone case makes India unattractive for investment.

The government must keep the obligations under the BITs in mind while taking any measures which can impact foreign investors. Coordination must be improved between the Ministry of Finance and all other ministries to discuss the obligations of India under the BITs before taking a step which may potentially affect foreign investors. Additionally, steps must be taken by the government to train the government officials from time to time for a better understanding of the international investment law.

India strives and has the potential to be an investor friendly jurisdiction and whether India will be able to achieve this goal, will depend on the advances that the government will make in its legislative framework. The approach of India to investment arbitrations needs to be revisited as the current position is showing a reverse trend. The efforts of the government and the judiciary cannot be ignored however, in spite of these efforts, India has not been able to achieve its goal of becoming the most preferred destination for investment. An overall improvement in the arbitration ecosystem will have a positive impact on ease of doing business which will eventually lead to more foreign investments.

Lastly, prima facie look at the India-Netherlands BIT would indicate that there is no specific exclusion (or inclusion) of disputes relating to taxation from the ambit of the BIT. In such a scenario, India’s conduct post termination of majority of its BITs in 2015, becomes relevant. For instance, the 2016 Model BIT in its Article 2.4(ii) states that the treaty shall not apply to “any law or measure regarding taxation, including measures taken to enforce taxation obligations”. Similarly, India issued a comprehensive joint interpretative statement for its BITs with Bangladesh, Finland, etc. which specifically ‘excluded the application of the BIT to any law or measure regarding taxation’. It is trite to note that both the Model BIT and the Joint Interpretative Statement were issued post termination of the India-Netherlands BIT, hence, it suggests that there was an inherent possibility of reading taxation related disputes in the previous/existing BITs (such as the India-Netherlands BIT). Even the PCA noted that ‘notwithstanding the Supreme Court’s 2012 decision, India violated its guarantee of fair and equitable treatment standard and the Tribunal gave the Award in favour of Vodafone.

This clearly indicates that not only does the Tribunal recognize and account for the Supreme Court’s decision, it is also clear that insofar as the “Taxation dispute” between India and Vodafone was concerned, it has, by all-means been decided by the Supreme Court and attained finality. Hence, India’s fundamental opposition that disputes related to taxation are excluded from the scope of the India-Netherlands BIT, has no standing whatsoever. Even if India decides to challenge the Award in Singapore on the basis of the aforementioned ground, it’s unlikely that such a ground will hold water.