Breach of a sovereign right

Context: International arbitration cannot be the solution to Cairn’s dispute. Government must look at administrative reform.

Background: The recent move by Cairn to seize India’s sovereign assets in order to enforce its arbitration award was thought by many to be a fitting response to India’s intransigence. However, it is important to reflect on the many grey areas of law that need due consideration.

Issues with the international arbitrations

• Breach of sovereign right to tax: Although Bilateral Investment Treaties (BITs) act as the primary tool to forge relationships between developed and developing countries, they still retain the old world constructs.
  • Many developing countries view arbitration of tax matters as a breach of their sovereign right to tax.
  • Taxation of cross-border incomes is resolved either through domestic dispute mechanisms or by competent authorities appointed to agree on an outcome not binding on the taxpayer.
• Lack of option of domestic arbitration: Upon an unsuccessful Mutual Agreement Procedure(MAP) resolution, the provision of domestic arbitration is not available in India.
  • BITs thus escape such constraints and provide the taxpayer with an opportunity to represent herself and quickly enforce an award, leading to a rise in arbitration awards in recent years.
• Retrospective taxation is deemed illegal:
  • While, in principle, retrospective amendments are not ideal, they are not unusual. For example, in the UK, such an amendment was introduced in 2008 to check the use of avoidance arrangements via the Isle of Man.  
  • While it is possible to challenge the constitutional validity of such pieces of legislation, the legislature has the power to amend the tax law.
  • A retrospective amendment may be acceptable where it intends to correct for a legal lacuna — provided it is not disproportionate. 
  • The 2012 explanations to the retrospective taxation under the IT Act sought to fix tax avoidance. The loss of tax on account of such legal lacuna is purportedly equivalent to the securities transaction tax collections in a year.

Way Forward: An end to the dispute seems unlikely. It raises many questions that administrators must address through reform. India’s model BIT introduced in 2016 rectifies the issue of dispute resolution through the specific exclusion of taxation.