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Cairn Energy and India Conundrum – Explained

by Tavaga Invest

Introduction –

Cairn Energy has been revisiting courts and subsequent conversations for almost a decade now to settle the claim. The government of India has appealed all the decisions while Cairn tries to claim its award. 

The Permanent Court of Arbitration at the Hague, Netherlands decided against the Indian Income Tax Department in December 2020 and awarded Cairn Energy a $1.4 billion arbitration award. The court also ruled that the Indian government’s retrospective tax demand in 2012 on Cairn Energy was “in breach of the guarantee of fair and equitable treatment”.

However, despite the desperate attempts of the company to reach a $600 million settlement, the case is continued as the Indian government ramps up pressure to concede and has no plans to comply with the decision.

Background to the tussle – 

This infamous Cairn case involves capital gains tax on a restructured company that was sold almost a decade ago. In 2006, the Edinburgh- based energy company decided to restructure its India operations by transferring ownership of its Rajasthan oil field to Cairn India (now Vedanta).

As a part of their master plan to reorganise the company, Cairn India acquired the entire Cairn India Holdings from Cairn UK Holdings in exchange for 69% of its shares. This acquisition as argued by the company was only to restructure the business and not to escape taxes, but the Indian Tax Department reasoned differently. 

In 2011, Cairn Energy took another controversial business decision to sell most of its Indian Holdings to Anil Agarwal’s Vedanta Resources for around $9 billion. However, the Indian tax authorities barred the sale of the remaining 9.8% of the company and froze any dividend payments from Cairn India to Cairn Energy. 

Retrospectively, the Indian government decided to amend the old and dusty tax rules for mergers and acquisitions in 2012. The new amendment granted the authorities to go after the deals all the way back to 1962 if the underlying assets were based in India. This crucial change in the law created hurdles and confusion in the already muddied water. 

In 2014, the Indian tax authorities contended that the UK energy giant owed $1.4 billion in capital gains tax from the fresh issue of shares of its Indian subsidiary on the Bombay Stock Exchange (BSE) in 2007. The Indian Tax Department also moved to seize 10% of Cairn India’s shares, valued at around $1 billion, to collect their old taxes. 

After miserably failing to resolve the issue in the Indian jurisdiction Cairn moved the dispute to the UK following the UK-India Investment Treaty and the company has been seeking international arbitration since 2015. 

In 2020 December, the Permanent Court of Arbitration at Hague overturned India’s retrospective tax demand of $1.4 billion. However, the Indian tax authorities filed an appeal in March 2021 on the ground that it is the sovereign right to tax an entity and on grounds of tax avoidance by Cairn Energy. 

Based on the appeal, the tax authorities have sought enforcement of the award in a lower Dutch court and is also ready to contest it at least eight other jurisdictions including the UK, Canada, the US and France.

On the other hand, since December 2020 Cairn Energy also started to file multiple cases in multiple jurisdictions like Singapore, Japan, UK, US, UAE, Netherlands, Canada, France and Cayman Islands for implementation of their arbitration award. This filing of cases was a well-thought strategy that enables the UK energy giant to identify commercial international Indian assets that it can seize including aircraft, bank accounts and ships.

However, the Government of India has strategically hinted at the possibility of resolving the dispute through the Vivad Se Viswas tax amnesty and dispute resolution mechanism.

Cairn Energy - India dispute timeline
Source: News Reports; Tavaga Research

What is going on and why is Cairn suing Air India?

As the situation and conversations between the two parties stand the arbitration issue is far from resolution with Cairn Energy. Cairn Energy has started to initiate the seizure of Indian assets rather than waiting for donkey years for an out of court settlement. 

Cairn Energy has taken inspiration from a similar dispute between Venezuela and ConocoPhilips. The US company sought seizure of Citgo, a PDSVA subsidiary and Venezeula’s crown jewel overseas asset to claim its arbitration award. This move pressurised the Venezeula authorities to move for a settlement more speedily.

Cairn Energy is moving forward with the same ConocoPhilips strategy by suing Air India. Cairn Energy main claim is that Air India can be considered an “Alter Ego” of the Indian government. Following this argument, Air India is severally and jointly liable for the Indian debt following the principle-agent relationship. 

Since Cairn’s announcement to go against Air India, the Indian authorities have been contacted several times for a response but they have failed to comment on the same. It can be deduced that the draconian action by the UK energy giant is solely to amplify the pressure on the government to come back to the settlement table. 

Additionally, the market regulator SEBI has imposed a fine of Rs. 5.25 crores on Cairn India for making a misleading statement regarding the buyback of shares in 2014. SEBI has also personally fined the CEO, directors and the company secretary of the company of Rs.15 lakh each. After a diligent investigation, SEBI concluded that the Cairn buyback did not take place despite the availability of adequate sell orders at NSE and was in violation of certain provisions mentioned in the Prohibition of Fraudulent and Unfair Trace Practises norms.

The timing of this action by the market regulator is viewed with a lot of scepticism by the market watchers and analysts.

The way forward – 

Earlier in 2021 Indian government had secretly asked the state-run banks to withdraw or reduce funds from their branches and accounts abroad as Cairn could possibly seize those funds.

Even though the policymakers, authorities and the ministries involved in the issue may not have known that Cair’s first salvo would be against Air India, they had been anticipating action from the company following the global precedent of Venenzeuala and ConocoPhilips issue.

While the Indian government is working parallelly and appealing against the arbitration award, the authorities need to be aware of the negative impact of such actions. These ongoing disputes with Vodafone and Cairn can discourage foreign companies from doing business in India and will directly affect foreign investments in the country.

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