The Perils of State Overreach

Context: The recent win of the Vodafone Group against India at the Investor-State Dispute Settlement (ISDS) tribunal, provides lessons to retain foreign investments in India if it follows the ruling.

Background

• Indian Parliament in 2012 amended the Income Tax Act: declared that income deemed to be accruing to non-residents, through the transfer of a capital asset situated in India is taxable retrospectively with effect from April 1, 1962.
• The ruling: The ISDS tribunal, constituted under the India-Netherlands Bilateral Investment Treaty (BIT), has ruled that India’s imposition of tax liability amounting to ?22,000 crores on Vodafone is in breach of India’s BIT obligations.

Issues with Retrospective Taxation: 

• Against the Supreme Court Ruling: The Court held that Vodafone did not owe any tax to the Indian State on account of acquiring a 67% stake in Hutchison Essar through an o?shore transaction. 
• Dented India’s reputation: as a country governed by the rule of law and shook the faith of foreign investors.
• A liberal democracy should avoid unleashing tax inspectors to extract money out of foreign investors by constantly changing the rules of the game.
• Tax Terrorism: The opposition called the amendment as an act of “tax terrorism” and is an Act of fiscal plundering hoping to mobilize sizeable revenues. 

Implications of the arbitral award:

• Ordered India to reimburse litigation costs to Vodafone: to the tune of more than ?40 crores incurred by Vodafone in ?ghting this case which will use up taxpayers’ money.

• Impact other ISDS claims: like cases related to Cairns Energy and Vedanta over retrospective taxation.

• The decision can be used to strengthen populist narrative: India might use this award to further harden its antagonistic stand against ISDS and BITs. 

• E.g. recently, India unilaterally terminated almost all its BITs after foreign investors started suing India for breaching BITs.
• The belief in Indian establishment is that the ISDS regime unduly intrudes into India’s sovereignty. The narrative is employed to hide the failure of regulation by the State.
• Displays the significance of the ISDS regime: The case is a reminder that the ISDS regime, not withstanding its weaknesses, can play an important role in fostering the international rule of law. 

Way Forward: 

• Need to internalize Bilateral Investment Treaties (BITs) and international obligations:  among the three organs of the State – Parliament, Executive, and Judiciary.

• These organs need to ensure that they exercise their public powers in a manner consistent with international law, or else their actions could prove costly to the nation.

• Learn the importance of values of the rule of law: as an important quality to win over the confidence of foreign investors.

• Avoid further litigation against the award: as it will send a deleterious signal to foreign investors reaffirming the sentiment that doing business in India is indeed excruciating.

Conclusion: If the government is serious about attracting foreign investors, it should immediately comply with the ISDS decision.