QUESTION : Sovereign right to tax recently was in news , exemplify this term and the issues associated with and steps taken by the government of India in this respect ?
The Hindu Editorial Topic : THE SOVEREIGN RIGHT TO TAX IS NOT ABSOLUTE
Sovereign Right To Tax
WHY IN NEWS ?
An important bill introduced in Parliament last week aims to nullify the regressive 2012 amendment in the Income Tax Act.
BACKGROUND OF THE DISPUTE :
- The arbitration between India and Cairn challenged the India retrospective taxation policy:
o In 2012, India brought in legislation mandating retrospective tax demands over deals going back to 1962 in which shares in non-Indian companies were transferred to an Indian holding company.
o In 2006-07, as a part of the internal rearrangement, Cairn UK transferred shares of Cairn India Holdings to Cairn India.
Later, when Cairn India divested roughly 30% of its shares through an Initial Public Offering, mining conglomerate Vedanta Plc acquired most of Cairn Energy.
But Cairn UK was not allowed to transfer its 9.8% stake in Cairn India to Vedanta.
o The Income Tax authorities then contended that Cairn UK had made capital gains and slapped it with a tax demand of Rs 24,500 crore.
- The Supreme Court of India had ruled against the retrospective reading of the law by tax officials in the case of Vodafone.
- However, Parliament passed a law mandating retrospective taxation over the transfer of Indian assets.
- This retrospective taxation, Cairn argued, was in breach of the UK-India Bilateral Investment Treaty.
o This treaty had a standard clause that obligated India to treat investment from the UK in a fair and equitable manner.
WHY IS CAIRN GOING AFTER INDIAN ASSETS ?
- In December 2020, a three-member international arbitral tribunal ruled unanimously that the Indian government was in breach of the guarantee of fair and equitable treatment, and against the India-UK Bilateral Investment Treaty.
o The breach caused a loss to the British energy company and ordered compensation of $1.2 billion.
- The Indian government is yet to accept the arbitration award. Cairn Energy is going after Indian assets overseas to recover the compensation.
- In May 2021, Cairn began the process of extracting the $1.2 billion.
WHY DID INDIA NOT ACCEPT THE AWARD ?
- Since the arbitration award was delivered in Hague, India has moved an appeal in the Netherlands.
- A similar arbitration verdict was delivered in September 2020 in favour of Dutch telecom company Vodafone.
- The award requires India to pay $5.47 million to Vodafone as partial compensation.
- After the World Wars, as more countries gained sovereignty, they tended to look at foreign investments as a form of neo-colonialism.
- For many years, policies in developing countries turned inward-looking.
o As a result, developed countries sought to guard their investments against expropriation.
o Bilateral investment treaties became the primary tool to forge relationships between developed and developing countries.
o Some argue that the US, in particular, signed BITs mainly to adopt standards for prompt, adequate and effective compensation in case of expropriation.
- Many developing countries view arbitration of tax matters as a breach of their sovereign right to tax.
o 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.
- The option of arbitration upon an unsuccessful Mutual Agreement Procedure (MAP) resolution is not available in India
o In fact, even when the OECD published its multilateral instrument for tax treaty amendment, India reserved the application of binding arbitration.
o BITs thus escape such constraints and provide the taxpayer an opportunity to represent herself and quickly enforce an award.
- All investments have tax implications and the acceptance of such a distinction could create problems even where tax is explicitly carved out from the bilateral investment treaties.
- A retrospective amendment may be acceptable where it intends to correct for a legal lacuna provided it is not disproportionate.
o The 2012 explanations to the IT Act of 1961 indeed sought to fix tax avoidance.
o The loss of tax on account of such legal lacuna is purportedly equivalent to the securities transaction tax collections in a year, which raises the question if the legislation has restored equity among taxpayers.
o The Cairns case retrospective tax has been challenged on grounds of denial of fair and equitable treatment, akin to expropriation.
INDIA’S OPTIONS GOING FORWARD :
- It is the first one to succeed for Cairn, the French court order boosts its chances in other jurisdictions.
- The assets will be tangled in a legal dispute and India will join a list of countries that includes Pakistan, Afghanistan whose assets were seized abroad.
- Unless it can be proved that the arbitration awards against India are mala fide in the appeals, the award can be enforced in foreign jurisdictions.
- However, a settlement between the two parties cannot be ruled out.
- Some suggest that India can invoke state immunity to stop the appropriation of its assets abroad.
- A better option would be to admit that amending the tax law retrospectively was a mistake and comply with the international ruling.
o Putting an end to this international embarrassment.
STATE IMMUNITY :
- State immunity can be invoked to resist the seizure of sovereign assets, but not commercial properties.
- It is a well-recognised doctrine in international law which safeguards a state and its property against the jurisdiction of another country’s domestic courts.
- This covers immunity from both jurisdiction and execution.
- Despite the universal acceptance of this doctrine, there is no international legal instrument in force administering its implementation in municipal legal systems of different countries.
- Attempts are underway to create binding international law on the application of the rules of state immunity such as:
o The United Nations Convention on Jurisdictional Immunities of States and Their Property (UNSCI).
o However, this convention is yet to be ratified by 30 countries — the minimum number required to bring it in force, as per Article 30(1) of UNSCI.
o India has signed the convention, but not ratified it.
- The doctrine of state immunity has progressed from absolute immunity (immunity from any foreign proceedings unless the state gives its consent) to restrictive immunity (immunity only for the sovereign functions of the state).
- By and large, most prominent jurisdictions follow the concept of restrictive immunity.
o In the context of the execution of the investment treaty arbitration awards, it implies that state property that serves sovereign functions (such as the property of the diplomatic missions, central bank assets, etc.) cannot be attached.
o However, properties serving commercial functions are available for seizure.
E.g., The International Court of Justice in the Jurisdictional Immunities of the State (Germany v. Italy: Greece intervening) recognised the exception for commercial assets.
o But, in practice, it is not always easy to draw an exact line dividing the two types of property.
- In the case of India, the most popular commercial property that foreign investors would target for attachment are the global assets of India’s public sector undertakings such as Air India.
o To attach the assets of these PSUs, it would have to be shown that these companies are nothing but the “alter ego” of the Indian state.
Is there any Indian precedent for such seizure of property belonging to foreign states?
- Seeking courts’ intervention in the enforcement of arbitration awards against foreign states is fairly common.
- Recently, in a case filed by two Indian private companies for enforcement of arbitral awards in their favour.
o The Delhi High Court directed the Embassies of Afghanistan and Ethiopia to file affidavits disclosing the assets owned and held by them in India.
o The Court held that:
A Foreign State does not have Sovereign Immunity against an arbitral award arising out of a commercial transaction.
Further entering into an arbitration agreement constitutes a waiver of Sovereign Immunity.
The agreement by the respondent to arbitrate the disputes would operate as a waiver of the said requirement.
When a Foreign State enters into an arbitration agreement with an Indian entity, there is an implicit waiver of the Sovereign Immunity, otherwise available to such Foreign State, against the enforcement of an arbitral award.
The very underlying rationale of international commercial arbitration is that of facilitating international trade and investment by providing:
- A stable, predictable, and effective legal framework within which commercial activities may be conducted to promote the smooth flow of international transactions and
- By removing the uncertainties associated with time-consuming and expensive litigation.
GOI STEPS TO RESOLVE THE ISSUE :
- The Union Finance and Corporate Affairs Ministry introduced the Taxation Laws (Amendment) Bill in the Lok Sabha recently to nullify the relevant retrospective tax clauses that were introduced in 2012.
- About the Taxation Laws (Amendment) Bill:
o As per the proposed changes:
Any tax demand made on transactions that took place before May 2012 shall be dropped, and
Any taxes already collected shall be repaid, albeit without interest.
To be eligible, the concerned taxpayers would have to drop all pending cases against the government and promise not to make any demands for damages or costs.
- Impact of the Taxation Laws (Amendment) Bill:
o It will bring past indirect transfer of Indian assets under the ambit of taxation.
- The rationale behind bringing such law:
o Such retrospective amendments militate against the principle of tax certainty and damage India’s reputation as an attractive destination.
o In the past few years, major reforms have been initiated in the financial and infrastructure sector which has created a positive environment for investment in the country.
o However, this retrospective clarificatory amendment and consequent demand created in a few cases continue to be a sore point with potential investors.
o This could help restore India’s reputation as a fair and predictable regime apart from helping put an end to unnecessary, prolonged and expensive litigation.
SOVEREIGN RIGHT TO TAX :
- Several Investor-State Dispute Settlement (ISDS) tribunals have recognised the fundamental principle that taxation is an intrinsic element of the state’s sovereign power.
- For instance, in a case known as Eiser v. Spain, where foreign investors challenged a tax imposed by Spain on electrical producers under the Energy Charter Treaty,
o The tribunal held that the power to tax is a core sovereign power of the state that should not be questioned lightly.
- Likewise, in El Paso v. Argentina, where the investors challenged several facets of Argentinian tax measures as breaching the United States-Argentina BIT,
o The tribunal held that the tax policy of a country is a matter relating to the sovereign power of the state, and
o The State has a sovereign right to enact the tax measures it deems appropriate at any particular time.
- Not just this, the ISDS tribunals have also held that whenever a foreign investor challenges states’ taxation measures, there is a presumption that the taxation measures are valid and legal.
- For instance, an ISDS tribunal in Renta 4 v. Russia said that when it comes to examining taxation measures for BIT breaches,
o The starting point should be that the taxation measures are a bona fide exercise of the state’s public powers.
- The tribunal in Cairn Energy v. India said that taxing indirect transfers is India’s sovereign power and the tribunal would not comment on it.
o However, such matters are not of absolute, unquestioning deference and there are limits on it.
o Thus, India’s right to tax in the public interest should be balanced with the investor’s interest of legal certainty.
o In the context of amending tax laws retroactively, such an action should be justified by a specific purpose that could not be accomplished by applying taxes prospectively.
- Limit on the right:
o The two most used BIT provisions to challenge a state’s taxation measures are expropriation and the fair and equitable treatment provision.
o In the context of expropriation,
one of the key ISDS cases that explained the limits on the state’s right to tax is Burlington v. Ecuador.
In this dispute, investors challenged Ecuador’s windfall tax imposed on excess profits resulting from oil exploration under the United States-Ecuador BIT.
The tribunal held that under customary international law, there are two limits on the state’s right to tax.
- First, the tax should not be discriminatory;
- Second, it should not be confiscatory.
In another ISDS case, EnCana v, Ecuador, a Canadian corporation sued Ecuador for value-added taxes under the Canada-Ecuador BIT.
- The tribunal held that a state’s tax measures would amount to an expropriation of foreign investment if the tax law is extraordinary, punitive in amount, or arbitrary in incidence.
o In the context of the fair and equitable treatment provision,
Foreign investors have often challenged taxation measures as breaching legal certainty, which is an element of the fair and equitable treatment provision.
Although legal certainty does not mean immutability of legal framework, states are under an obligation to carry out legal changes such as:
- Amending their tax laws in a reasonable and proportionate manner.
RETROSPECTIVE TAXING :
- As the name suggests, retrospective taxation allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.
- Significance: Countries use this route to correct any anomalies in their taxation policies that have (in the past) allowed companies to take advantage of such loopholes.
- Impact: While governments often use a retrospective amendment to taxation laws to clarify existing laws, it ends up hurting companies that had knowingly or unknowingly interpreted the tax rules differently.
- Countries using this approach: Apart from India, many countries including the US, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies, which had taken the benefit of loopholes in the previous law.
PERMANENT COURT OF ARBITRATION (PCA):
- It is an intergovernmental organization established by a treaty at the First Hague Peace Conference, Netherland in 1899.
- It is not a court, but rather an organizer of arbitral tribunals to resolve conflicts between member states, international organizations, or private parties.
- It seeks to facilitate arbitration and other forms of dispute resolution involving various combinations of states, state entities, international organizations and private parties.
- It also administers cases under the arbitration rules of the UNCITRAL.
- It is not a United Nations agency but an official United Nations Observer.
- All its decisions – called “awards” are binding on all the parties in the dispute and have to be carried out without delay.
- Membership of the PCA:
o Parties to the Convention on the Pacific Settlement of disputes of 1899 (71 member states) and 1907 (101 member states) are automatically parties to the PCA.
o As 51 are parties to both conventions, the PCA has 121 member states – 119 members of the United Nations, as well as Kosovo and Palestine.
o India is a party of the PCA according to the Hague Convention of 1899.
The biggest takeaway from this nine-year-long sordid episode of retrospective taxation is that India should exercise its right to regulate while being mindful of its international law obligations, acting in good faith and in a proportionate manner.
QUESTION : “Closing down the old coal power plants using age as the only criteria can prove to be counter-productive.” Critically analyse this statement
The Hindu Editorial Topic : REVISIT THE IDEA OF ‘AGING OUT’ INDIA’S COAL PLANTS
Shutting Down of Old Coal Power Plants
WHY IN NEWS ?
As part of the Union Budget address for 2020-21, the Finance Minister, said that the shutting down of old coal power plants, which are major contributors to emissions, will aid the achievement of India’s Nationally Determined Contributions.
MORE ABOUT THS NEWS :
- It is argued that the availability of under-utilised newer (and presumably more efficient) coal-based capacity means that shutting down older inefficient plants would lead to improved efficiencies, reduced coal usage, and hence, cost savings.
- It is argued that it would be uneconomical for old plants to install pollution control equipment required to meet the emission standards announced by the Environment Ministry, and hence it would be better to retire them.
- The recent order from the Central Electricity Regulatory Commission (CERC) allowing Delhi’s BSES distribution company to exit its concluded 25 year old power purchase agreement with the National Thermal Power Corporation Limited’s Dadri-I generating station, also lends some credence to this.
- While there are some old plants tied up in expensive power purchase agreements, as in the case of the CERC order, there are also several old plants, which generate at lower costs.
o For instance, plants such as Rihand, Singrauli (both Uttar Pradesh), and Vidhyanchal (Madhya Pradesh), are all over 30 years old and have very low generation costs of around ₹1.7/kWh, which is lower than the national average.
- The total savings in generation cost from shutting down plants older than 25 years would be less than ₹5,000 crore annually, which is just 2% of the total power generation cost.
o These savings may not be sufficient to even pay for the fixed costs (such as debt repayment) that would have to be paid anyway, even if the plants are prematurely retired.
o Similarly, savings in coal consumption by replacing generation from plants older than 25 years with newer coal plants are also likely to be only in the 1%-2% range.
- The argument about older plants finding it uneconomical to install pollution control equipment to meet environmental norms is a stronger one, as all coal plants should indeed reduce emissions.
o However, even here, the argument is not black-and-white. There are some old plants that may continue to be economically viable even if they install pollution control equipment as their current fixed costs (which would increase with pollution control equipment installation) are very low.
o Indeed, about half the coal capacity older than 25 years has already issued tenders for pollution control equipment installation.
INDIA’S NATIONALLY DETERMINED CONTRIBUTIONS :
- Intended Nationally Determined Contributions (INDC) are (intended) reductions in greenhouse gas emissions under the United Nations Framework Convention on Climate Change (UNFCCC).
- The INDCs combine the top-down system of a United Nations climate agreement with bottom-up system-in elements through which countries put forwards their agreements in the context of their national capabilities, circumstances and priorities with the goal of reducing greenhouse emissions.
- The INDC in itself has safeguards which help in emission reductions and also address steps taken to adapt to climate change impacts along with looking into what the country needs to implement such steps.
- India’s INDC, to be achieved primarily, by 2030
o To reduce the emissions intensity of the GDP by about a third.
o A total of 40% of the installed capacity for electricity will be from non-fossil fuel sources.
o India also promised an additional carbon sink (a means to absorb carbon dioxide from the atmosphere) of 2.5 to 3 billion tonnes of carbon dioxide equivalent through additional forest and tree cover by the year 2030.
ITS CONCERNS :
- Whether these limited savings are worth the risks associated with early retirement of coal plants, especially given the current trends in the country’s power sector.
o To support the growing intermittent renewable generation in the sector, there is an increasing need for capacity that can provide flexibility, balancing, and ancillary services.
o Old thermal capacity, with lower fixed costs, is a prime candidate to play this role until other technologies (such as storage) can replace them at scale.
- There is also a political economic risk, as aggressive early retirement of coal-based capacity, without detailed analyses, could result in real or perceived electricity shortage in some.
WAY FORWARD :
Strategic Decommissioning of Old and Inefficient Power Plants: It may be prudent to let old capacity fade away in due course and saving some of them as they are efficient, while focusing on such detailed analysis and weeding out the needless capacity in the pipeline, to derive long-term economic and environmental benefits.
Cost Effective Solar Plants: The average cost of coal-fired projects is Rs.4 per unit and generally sees an upward escalation, whereas new solar power plants are being bid out at less than Rs.3 per unit.
Encourage Private Sector: New private competition can bring new capital and more innovation.
o New coal-fired power plants are still being financed so that the private sector is not building any coal-based power plants at all; only the public sector power companies are doing so. These PSU thermal plants are financed by public sector banks and largely on taxpayers’ money.
UDAY 2.0: Government’s announcement of the launch of UDAY 2.0 which seeks installation of smart prepaid meters, prompt payment by discoms, making coal available for short term and reviving gas-based plants is a step in the right direction.
Flexible Contracts: Long-term supply contracts need flexibility for public utilities to adapt to unforeseen situations such as a Covid-19 collapse in demand.
It may be prudent to let old capacity fade away in due course, while focusing on such detailed analysis and weeding out the needless capacity in the pipeline, to derive long-term economic and environmental benefits.