Cairn Energy in India
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A Backgrounder
1996-2021
Ajit Ranade, July 23, 2021: The Times of India
India is the only large Asian economy with a consistent trade deficit. Which means that its imports are always in excess of its exports, even counting export earnings from software services and remittances from non-resident Indians abroad. This annual dollar shortage is more than made up by capital inflows, in the form of dollars flowing into the stock market, as foreign loans and as Foreign Direct Investment.
One reason for India’s high imports is high dependence on imported crude oil. We produce barely 20 per cent of our total need, the major producer being ONGC. To encourage oil exploration in on-shore and off-shore oil fields, we have tried to invite many global players to invest here. One such company, which came to India is 1996, is Cairn Energy, a leading European company in oil and gas exploration, listed on the London Stock Exchange.
Cairn struck oil in the Rajasthan desert in 1999. Between 2000 and 2005, three of the seven landmark oil or gas discoveries in India were made by Cairn. In 2006, the local company, Cairn India Limited, had a thumping listing on the Bombay Stock Exchange, and its share ownership was offered to the public at large. By 2010, one of the main oil fields in Rajasthan, called Mangala, was producing 1.25 lakh barrels per day.
But let us rewind a bit. Until 2006, all the India operations of Cairn were under a foreign company called Cairn UK Holdings Limited. In August 2006, Cairn UK Holdings moved all its shares in various Indian assets, to a newly-created entity called Cairns India Holding Limited (CIHL), incorporated in Jersey - a tax haven island off the coast of France. Now why Cairn UK had to move shares of its Indian assets to a tax haven, is a side story which need not distract us here. Suffice it to say that much FDI has flowed into India for many decades through tax havens like Jersey and Mauritius. Recall that in October 2006, Cairn India Limited was born, as a wholly-owned subsidiary of Cairn UK. To this child company, Cairn UK sold all its shares that it held in Cairn India Holdings of Jersey (remember in August, Cairn UK had consolidated its Indian assets into Cairn Jersey?). This Indian company now “owned” the Jersey company, and it was the same company that later in December 2006, had an IPO.
Enter the taxman. In January 2014, India’s tax department initiated reassessment proceedings against Cairn UK, to determine its tax liability on the capital gains it had made by way of sale of its shares in Cairn Jersey to Cairn India Limited. Cairn UK had always maintained that its profit was made on the soil of Jersey which - being a tax haven - had zero tax implication.
A non-resident entity (Cairn UK) had sold its shares in another non-resident entity (Cairn Jersey) to an Indian company (CIL). Where was the question of paying taxes to India on the profit so accrued? Aha! said the Indian taxman. Most of the value of that 2006 transaction came from prized assets located in India. So India had a claim to tax that profit. And why did the taxman wait till 2014 to reassess that transaction? Because in 2012, India’s Parliament amended the tax law that said that any capital gains made from the transfer of shares from a foreign entity (Cairn UK) to its assets located in India (Cairn India), will be taxable from 1962.
This retrospective amendment, going back nearly 50 years, was brought in to defeat a Supreme Court verdict in a similar tax case that the government had lost against Vodafone. Thanks to the amendment, the immunity granted by the Supreme Court judgment to foreign investors was no longer available for such offshore deals. So this tax dispute with Cairn UK dragged on since 2015, even though it had sold a majority of its shareholding in Cairn India to Vedanta in 2011. Cairn claimed that the tax demand was illegitimate and unjustified. Meanwhile India confiscated Cairn’s residual stake in Cairn India (now part of the Vedanta group), which was worth about $1.7 billion, and has also withheld the dividend payments due to Cairn over all these years. In March 2015, Cairn initiated international arbitration against India, citing violation of the India-UK bilateral investment treaty. India tried to ‘stay’ the proceedings, and even attempted to bifurcate issues of jurisdiction, ie, whether the arbitration panel could even rule on this dispute. But after twists and turns, finally in December 2020, the panel ruled in favor of Cairn, and said that India had violated Article 3 of the India-UK investment treaty.
The panel stated that India has failed to provide favourable conditions, ie, FET (Fair and Equitable Treatment) clause of the BIT. So India has to now pay - including penal interest - about $1.7 billion to Cairn. It is unclear whether Indian courts will allow Cairn to enforce the arbitration judgment in India. But the arbitration award is enforceable in more than 160 countries (including India) that have signed and ratified the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.
Following this, Cairn has secured an order from a court in France to seize about 20 Indian government properties in central Paris. Cairn has also registered the arbitration award in other international jurisdictions including the US, the UK, Canada, Singapore and the Netherlands. For its part, India says its “sovereign assets” are immune from getting seized. But it’s not clear whether the immunity extends to all the French properties - some of which surely are being used for commercial purposes, not diplomatic or sovereign functions.
India plans to appeal against the arbitration award. But this is not going to help its image as a country hospitable to foreign investment. It has already lost a similar international arbitration case against Vodafone which, too, may go into appeal. India claims these are matters of its sovereign rights to tax. But the Cairn case award says this is about investment protection.
Either way, having Air India aircraft or property being seized would be very embarrassing. Also, the route of resorting to retrospective tax law amendments itself is pernicious and appears vindictive. The best course of action would be to settle these pending issues amicably without further litigation. If India has to achieve high and sustained growth, or even achieve Atmanirbhar status, being hostile to foreign investors is not going to help. Remember, India always needs foreign investments to plug its dollar shortfall on the trade front. More red carpet, and less red tape - that’s the mantra to follow, not just to foreign but also domestic investors, big or small.
