MIS Asia recently published a blog post that I prepared entitled “India under the Bilateral Investment Treaty Arbitration spotlight”. It was also picked up on Computerworld Singapore, Computerworld Malaysia and CIO Asia. I’ve set out the full text below for the benefit of everyone following this blog: 

In January 2012, the Indian Supreme Court ruled that Vodafone was not liable to account for a whopping US$2 billion in withholding tax on its 2007 acquisition of indirect interests in Hutchinson Essar Limited. That appeared to have brought an end to the British telecom major’s long running dispute with India’s tax authorities. Foreign investors in India, many of whom who had structured similar Vodafone-like deals, breathed a huge sigh of relief. So did their tax advisors.

Then news broke in March that the Indian government was proposing retrospective tax legislation in the Indian Finance Bill 2012 which, if enacted, would effectively annul the Indian Supreme Court’s January 2012 verdict in favour of Vodafone. Observers who were keen to see how Vodafone would respond, did not have to wait long at all.  

As it turns out, I was on a business trip in Mumbai on 17 April when Vodafone announced that it’s Dutch subsidiary Vodafone International Holdings BV had served the Indian government with a Notice of Dispute (“Notice”) regarding “proposals in the Indian Finance Bill 2012 that violate the international legal protections granted to Vodafone and other international investors in India”.

Vodafone’s Notice invokes Article 9(1) of the Bilateral Investment Treaty (“BIT”) between India and the Netherlands (“the Treaty”) and kick-starts a three month window for Vodafone and India to negotiate and, hopefully, reach an amicable resolution to their dispute without having to resort to arbitration. If there is no settlement, the Treaty allows parties to agree to refer the dispute to conciliation. However, this step is optional and given that conciliation is not much more than a structured form of settlement discussions, Vodafone may very well prefer to skip this step and refer the dispute directly to BIT arbitration.

It may be premature to discuss BIT arbitration in the above context when the Indian Parliament hasn’t yet passed the proposed retrospective tax legislation into law. But that doesn’t seem to have stopped India from planning to set up an inter-ministerial group comprising representatives from all concerned ministries and departments to craft an appropriate response to the Notice. Neither has it stopped India’s Minister of State for Finance from announcing the income tax department’s estimate that “The total tax implication in consequence of retrospective amendments introduced in the Finance Bill may be to the tune of Rs 35,000 – 40,000 crore”, i.e. approximately US$6.6 – US$8.5 billion.  

Pressure is also mounting from the international community for India to clarify its stance towards foreign investment into the country. On 19 April 2012, US Treasury Secretary Timothy Geithner pressed India’s Finance Minister Pranab Mukherjee to “reassure foreign investors that India will continue to welcome foreign capital, by advancing important economic reforms that will increase opportunities for bilateral trade and investment and strengthen India’s business climate through greater transparency and predictability.” UK Chancellor of the Exchequer George Osborne has also warned that India’s proposed retrospective tax legislation will “damage the overall climate for investment in India”.

India is not unfamiliar with BIT arbitration – just last November, an arbitration tribunal constituted under the UNCITRAL Rules and sitting in Singapore in the White Industries arbitration against Coal India ruled that India had violated the terms of the India-Australia BIT. With Sistema and Telenor also recently threatening arbitration against India over the India Supreme Court’s cancellation of their 2G licenses, India is firmly under the BIT arbitration spotlight.

India is facing a tricky situation here with these potential arbitrations lining up. On the one hand, it would obviously like to retain and also increase the level of foreign investment in the economy. It needs to maintain a level of predictability and certainty in its laws and policies in order to achieve that, otherwise the risk of investing in India becomes too expensive and ultimately unattractive. But, quite understandably, India also doesn’t want unwarranted external interference with its own policies, judicial, or legislative processes. Nobody does.

The next few months will be critical for India as it tries to strike the right balance. If India ultimately passes the proposed retrospective tax legislation into law and Vodafone commences arbitration as it says it will, then we may very well see a proliferation of similar arbitrations commenced by other affected investors against the Indian government- potentially a further US$6.5 billion worth of arbitration if the estimated figures quoted by the income tax department turn out to be accurate.