Analysing India’s Resistance to Arbitration in Tax Disputes under the New York Convention – A Call for Hybrid Solutions

The author is Vivek Serjy, a Fifth Year Student from Christ University, Bangalore.

Introduction

In the 21st century, the world has witnessed unprecedented globalisation, with many MNCs venturing into global investments and generating substantial revenue. This international context is crucial to understanding the dynamics of Double Taxation Agreements and the Mutual Agreement Procedure (MAP) for resolving tax disputes, which aim to prevent Double Taxation.^[1]

However, there are drawbacks within MAPs due to firstly(i) the duration of time it took; secondly(ii) there was no finite resolution as an outcome,; and thirdly(iii) there is involvement of taxpayers. Foreign direct investment (FDI) is crucial now for the creation of economic opportunities in India. However, India has received negative publicity for its friendliness toward foreign investment due to the notorious retrospective taxation treatment of two foreign companies, Vodafone and Cairn Energy. Moreover, India is repudiating the mandatory International Tax Arbitration (ITA) under the Bilateral Investment Treaty (BIT), as some of the reasons involve sovereignty and public policy principles that affect the State as a whole.

It is unwise for India to hold firm against the mandatory ITA, as most MNCs prefer arbitration as an effective and speedy resolution system. Arbitration has proven fruitful in several international commercial disputes. Moreover, International Tax Arbitration has been favoured and promoted by several tax conventions, such as the OECD BEPS and the UN Tax Committee. Henceforth, the essay focuses on several aspects of India’s resistance and the need to emancipate from such shackles. The essay focuses on the possibility of a hybrid Med-Arb or Arb-Med solution that ensures India's sovereignty is not affected and, at the same time, provides an amicable dispute resolution with MNCs.

Sovereignty and Tax: India’s Constitutional Imperative

To understand why India is resistant to Tax Arbitration, we need to first understand India's stance on taxation in the Constitution. India is one of the countries that views taxation as a solely sovereign subject. The Indian Government has been vociferously opposed to giving up its taxation rights to Arbitration, as it perceives it as ceding some of India’s sovereignty to a third party.  For instance, India immediately brought a retrospective amendment to close the loophole in Section 9 of the Income Tax Act that exempted indirect transfers from taxation, thereby nullifying the effect of the Supreme Court’s favoured decision in Vodafone. The outcome resulted in Vodafone filing a case in the Permanent Court of Arbitration over the ground of a violation of fairness under the Netherlands-India BIT. Vodafone filed a case before the Permanent Court of Arbitration on the grounds of a breach of fairness under the Netherlands-India BIT. The award was in Vodafone's favour.

Due to setbacks in the Vodafone and Cairn Energy Arbitration cases. India has amended several articles of the BIT to exclude issues that compromise India’s ‘sovereignty’. This amendment can be inferred to mean that India is not in favour of international compulsory tax arbitration on public policy grounds. For instance, in the 2016 Indian BIT Model^[2], the taxation measure for arbitration has been excluded except for the Double Taxation Avoidance Agreements (DTAA)^[3]. India can take such measures to exclude the tax under arbitration, as taxation under International law is a prerogative of a sovereign state.

Indeed, specific subjects that involve public policy in an excellent manner cannot be arbitrable, such as competition law, securities law, intellectual property, and trade barriers and tariffs. Taxation is distinct as it incorporates the public policy element, such as the ambit of services the government can render. However, not all issues of taxation are applicable in arbitration; rather, it is the issues particular to the sovereign decisions of India in the applicable tax dispute.

India should not harden its stance on ITA, and instead, it should allay and engage with the other party to resolve the dispute under ITA. There are several limitations of MAP which arbitration can surpass as a remedy. Firstly, the is time-consuming. According to OECD statistics, it took an average of 2 years and 3 months  to complete MAP. Secondly, there is no , as the competent authorities are not under pressure to provide one. This is not ideal for foreign MNCsday's delay incurs a high cost. Lastly, taxpayers are not at all involved in the MAP deliberations. This raises the question of fairness in the MAP procedure.

By embracing International Tax Arbitration (ITA), India can bridge the trust deficit with foreign MNCs, offering them more involvement and transparency in the proceedings. This shift can significantly improve India's investor-friendly status, paving the way for a more optimistic future in international tax law. addresses the trust deficit faced by foreign MNCs, as they are more involved. There is greater, as it will improve its investor-friendly status through Public Policy Exceptions in the Indian Court.

We also need to understand the situation of Arbitration in India with respect to Judicial enforcement of Arbitral Awards to understand why MNCs are hesitant to Tax Arbitration, and how solutions like Med-Arb or Arb-Med could provide effective redressal of tax disputes without affecting India's public policy.

India has a poor reputation for setting aside arbitral awards. The most used ground for setting aside was public policy. The setting aside of arbitral awards has been recognised in the UN Convention under Article 5, which provides that the competent authorities may set aside awards if it violates the public policy of the State. However, in India, public policy has not been defined in the Explanation^[4] of Section 48(2) of the Arbitration & Conciliation Act 1996^[5]. public policy has not been defined in Section 48 of the Arbitration & Conciliation Act. This absence of definition has broad given the Indian Judiciary broad discretion to define public policy, as seen in a series of cases that, in turn, eroded trust in Arbitration's efficacy in India.

The Supreme Court in Renusagar Power Ltd Co v General Electric Co (1994) Supp (1) SCC 644 has given an interpretation of the violation of public policy if the award is contrary to (i) the fundamental policy of Indian law, (ii) the interests of India, (iii) justice and morality. The Supreme Court advocated for restrictive usage , subject to wider judicial discretion within these contours. The, as it would ultimately defeat the benefits of compelling arbitration.

The Indian Judiciary has also been at a crossroads concerning the application of public policy exceptions. For instance, in Bhatia International v. Bulk Trading (2002) 4 SCC 105, the Supreme Court held that the remedies under Part I must be available to international parties as well. The considerable created significant ambiguity.

After massive criticism, the amendment in Bharat Aluminium Co v Kaiser Aluminium Technical Services Inc (2010) 1 SCC 72 and the Amendment of the Act, Section 34 of the Act is solely for domestic arbitration. Section 48 does include the Court  in investigating the merits of the case, except in a patent illegality application. Moreover, the 246^th Law Commission Report has suggested reducing the public policy to merely justice and morality.^[6]

In Singapore, the definition of public policy is narrowly. Justice Prakash observed in the Hainan case, ‘As a nation which itself aspires to be an international arbitration centre, Singapore must recognise foreign awards if it expects its awards to be recognised abroad.’ — Re An Arbitration [1996] 1 SLR 34 at p 46. In England, the invocation of public policy is not reviewed on the merits of the case. In Honeywell International Middle East Limited v. Meydan Group LLC, DIAC Case No 201/2010, the court confirmed that the threshold to set aside an award based on public policy violations is very high when it held that “public policy should only be invoked in clear cases.

At present, India is aiming to create a world-class arbitration hub by inculcating international arbitration standards. India has transitioned from a restrictive stance on public policy to a more streamlined approach. The Supreme Court’s ruling in the case of Vinay Karia v. Prysmian Cavi E Sistemi Srl & Ors (2020) 11 SCC 1, where the Supreme Court acknowledged the pro-enforcement bias in the UN Convention and the parties contesting ought to restrict themselves to the grounds laid in the Statute.  Also, Vikas Goel, the Senior Partner of Singhania & Partners, wrote in his blog that the Vinay Karia case has laid out the broad principles for understanding the meaning of the expression ‘public policy’, and there is no straitjacket formula for deciding. , limiting it to, as its effectiveness can be achieved through India's cooperation in    

Conflicting International Obligations

The OECD MLI has out, the MAP remedy for tax disputes. If the MAP does not resolve the conflict, the MAP remedy is exhausted. If the MAP does not resolve the dispute, mandatory arbitration is commenced as part of the remedial process. Compulsory arbitration is an extension of the MAP under Article 19 of OECD MLI.^[7], where the arbitration will commence only when the Competent Authority has not followed the Covered Tax Agreement.

Part VI of the OECD MLI addresses arbitration in tax treaties and lays out the process and procedures if the issues are unresolved in the MAP and the parties want to resolve them under arbitration. The parties wish to resolve them under the arbitration in tax treaties and lay out the process and procedures if issues are unresolved in the MAP. The parties want to resolve them through binding arbitration. India ratified the OECD MLI but did not sign Part VI, which concerns mandatory arbitration. The Finance Minister, Nirmala Sitharaman, inferred that taxation is a sole sovereign subject of the State, which cannot relinquish a part of it for arbitration, and that India is not in favour of such arbitration due to very costly arbitral claims by investors averaging $1.1 billion. The unfavourable awards against India      its agreement in Vodafone and Cairn Energy arbitration cases, leading India to reconsider and agree to mandatory tax arbitration.

Impact on Foreign Investment

India entered BITs with many countries, and there is goodwill from foreign companies that they are subject to BITs with many countries and that they will be treated fairly and equitably. However, it was not  in a massive tax claim of $4 billion.

The Government of India was perturbed by the arbitral award  in favour of Cairn Energy for $1.3 billion. Despite initial reluctance to pay the award, which further eroded India's image with foreign investors, the Government of India finally paid heed to the settlement with Cairn Energy and, in return, agreed to withdraw all litigations in many countries over the seizure of assets owned by the Government of India. However, India has witnessed a 22% decline in FDI since 2021-22 (apparentpost-Cairn Energy), which reflects the apparent anguish of foreign investors. This anguish among MNCs underscores the need for a hybrid Med-Arb solution that could yield fruitful results for both MNCs and the Indian Government, which has deep distrust of International Arbitration in taxation matters since the Cairn and Vodafone cases.

Hybrid Solution of Med-Arb to the Problem of Tax Arbitration

India has not favoured international tax arbitration since the Vodafone and Cairn Energy case. Agreeing to the Arbitration would be tantamount to relinquishing some of its state sovereignty, which the Government of India is not interested in. However, foreign companies and investors strongly favour the inclusion of a mandatory binding arbitration clause in Tax treaties. Arbitration is a better alternative to MAP, which is time-consuming and cumbersome and may not provide a fruitful remedy.

In this scenario, India could consider a hybrid Arbitration model, such as Med-Arb. In this model, the government of India and the foreign company or investor could first engage in mediation to secure a mutually satisfactory outcome. The next stage of Arbitration would only be moved to when the mediation stage ends in impasse, and there is no possibility of further negotiations.

In the end, it is the parties who want a favourable, win-win resolution. India must strategically adopt a hybrid model to safeguard its sovereignty and ensure that foreign companies pay their fair share of taxes. The flexibility and finality of Med-Arb, coupled with its counterbalance to the adversarial drawbacks of sole Arbitration, make it an ideal resolution model for India. The success of Med-Arb has been witnessed in the IBM v. Fujitsu and California Nurses Association cases. foreign companies and investors strongly favour the mandatory binding arbitration clause in Tax treaties, as arbitration is a better alternative to MAP, which is time-consuming and cumbersome and may not provide fruitful remedies or noneadopting a hybrid arbitration model,mediation to secure a fruitful outcome that satisfies both parties. They could engage in mediation to ensure a mutually satisfactory outcome in impasse and see      an impasse, and there is. India, as it could safeguard its sovereignty and allow foreign companies to claim their rightful tax payments. India must strategically consider such a hybrid model, as it could maintain its independence. Foreign companies can claim their rightful tax payments and seek a favourable, win-win resolution. India must strategically consider such a hybrid model, as it could safeguard its sovereignty while allowing foreign companies to claim their rightful tax paymentsfinality of Med-Arb, coupled with countering the adversarial drawbacks of sole Arbitration, make it 

Conclusion

Regarding sovereignty concerns, India's resistance to tax arbitration is understandable, but a hybrid Med-Arb model could balance the state interests with investors' confidence. India can achieve its goal of becoming a world-class arbitration hub by implementing these reforms while also protecting its fiscal autonomy. India can transform from a sovereignty-centric outlier to a global arbitration leader by adopting a Med-Arb framework and narrowing down public policy exceptions. The choice is clear for India: reform; otherwise, risk irrelevance in the race for foreign investment.

References

[1] It is an International Tax norm that Income is taxed only once. Therefore, Double taxation refers to income tax being paid twice by two countries on the exact source of income, for instance, stock dividends. To prevent Double Taxation, the countries enter a Bilateral Investment Treaty, which states terms on the taxation, and if by chance any dispute arises, it would be resolved through a Mutually Agreed Procedure by appointing competent authorities (who are usually Tax officials from respective countries). 

[2] Government of India, Model Text for the Indian Bilateral Investment Treaty (2016), Art 2.4(iv)

[3] It is understandable from the viewpoint of the government of India to allow only mandatory ITA in DTAA as mandatory ITA is very costly, which includes the cost of reduced sovereignty.

[4] Section 48(2) of Arbitration & Conciliation Act 1996: -

Enforcement of an arbitral award may also be refused if the Court finds that

(a)the subject matter of the difference is not capable of settlement by arbitration under the law of India or

(b)The award enforcement would be contrary to India's public policy.

[Explanation 1. [Substituted by Act No. 3 of 2016 dated 31.12.2015.] - For the avoidance of any doubt, it is clarified that an award conflicts with the public policy of India only if-

(i)the making of the award was induced or affected by fraud or corruption or was in violation of section 75 or section 81; or

(ii)it is in contravention of the fundamental policy of Indian law; or

(iii)it conflicts with the most basic notions of morality or justice.

 Explanation 2. - To avoid doubt, the test of whether there is a contravention with the fundamental policy of Indian law shall not entail a review of the merits of the dispute.]

[5]

[6] Law Commission of India, 246^th  Amendments to Arbitration and Conciliation Act 1996 (August 2014) Pg. 57 Para 22

[7] OECD, Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (2016), Art 19.