The last week began with the news of Cairn Energy filing a notice for settlement of disputes with the Indian government under the Agreement for Promotion and Protection of Investments between UK and India. The dispute stems from a tax demand in an amount of $1.6 billion raised by the Indian Income Tax Department on Cairn Energy. The basis of the tax demand is an alleged capital gain made when Cairn Energy transferred its Indian business to a newly incorporated Indian entity in 2006 pursuant to a group re-organization. In addition, Cairn Energy has been prohibited from selling its residual stake of circa 10% in the Indian entity by the Indian Income Tax Department, whose value is said to have diminished in the period of the restriction.
At the heart of this tax demand, lies the retrospective amendments to the Indian tax code carries out in 2012 to provide for the taxation of indirect transfers of shares, post the landmark Supreme Court judgment in the Vodafone case in favour of the taxpayer. The amended law clarified that any share or interest in a foreign company will be deemed to be situated in India if its value substantially derives, directly or indirectly, from assets located in India. Accordingly, for historic cases which could be investigated under the retrospective provisions, this is a danger that will remain unless the government takes an in principle decision not to invoke these provisions. Several announcements from the current government had raised the expectations of the investor community that such cases will not be pursued. Further, in the recently laid out Budget, the term ‘substantial’ was proposed to be clarified to mean cases where the value of Indian assets: (i) exceed INR 100 million; and (ii) represent at least 50% of the value of all assets owned by the foreign company. The gains from indirect share transfers are proposed to be taxable in India on a proportionate basis i.e. to the extent the gains are reasonably attributable to assets located in India.