The Retro Tax Was Bad, India. Don't Make It Worse

Back when global investors still believed Prime Minister Narendra Modi would keep his promise to end the previous regime's "tax terror," his newly elected government made a costly error. In March 2015, someone in India's labyrinthine bureaucracy decided to send a revenue demand to U.K.'s Cairn Energy Plc - ruining Chief Executive Officer Simon Thomson's birthday.

This March 10, Thomson has every reason to celebrate both his birthday and victory in a tortuous legal saga that ended right before Christmas with a $1.2 billion international arbitration award in Cairn's favor. But there's still one big glitch: The check that should have been in the bank by now isn't even in the mail. That raises the unpleasant prospect of a private company having to legally seize sovereign property globally, a course of action some of its shareholders are starting to recommend.

"It would be truly unfortunate if this were the only path to resolution but in the absence of India adhering to the ruling, the company may be left with no other choice as it has a fiduciary duty to act," says Stan Majcher, a portfolio manager at Los Angeles-based Hotchkis and Wiley Capital Management, which owns more than 2% of Cairn.

It's been arduous and time-consuming for private firms to seek enforcement against Venezuela, Qatar, Lithuania and Tunisia. But when the sovereign in question is the world's largest democracy and a rising economic power, things could get outright messy. For India, it will also be a PR disaster. After giving assurances that it would honor the verdict, not doing so makes New Delhi appear unpredictable and recalcitrant. "Cairn's claim needs to be resolved, and nobody wants it resolved this way," Majcher said in an email.

Maybe India is dragging its feet to explore some kind of an appeal, even though the arbitration panel in The Hague was unanimous, and the whole point of the exercise was to resolve the dispute with finality. Or perhaps politicians and bureaucrats are too distracted by the ongoing vaccination drive, the upcoming federal budget, this week's farmers' protests and other pressing matters.

Hubris could also be coming in the way. Last year, when most large recipients of foreign direct investment reported big declines, and China eked out a modest 4% gain, India came out ahead with a 13% jump in FDI. A large chunk came chasing the digital and retail businesses in which Mukesh Ambani, India's richest man, raised equity. Yet the country may well be on the cusp of an influx of money that wants to flee the U.S.-China trade war by exploiting liberal "Make in India" production-linked incentives. 

Perhaps the main hitch is political inertia. By not making a clean break after the 2014 polls from the Manmohan Singh government's draconian retrospective taxation, the Modi administration missed a fleeting opportunity for a reset in what has traditionally been a testy relationship between the state and the private sector. It's too late to get any political mileage out of making amends. So, the feeling may go, why sign the check?

Public memory is too short to care that the mess originated in Singh's final years in power. His government, besieged by allegations of corruption in everything from the 2010 Commonwealth Games to 2G spectrum awards, decided to make an example of another U.K. investor, Vodafone Group Plc. The taxman contended that while buying the Indian wireless business of Hong Kong billionaire Li Ka-shing in 2007, the British telco should have withheld a portion of Li's capital gains. After the Supreme Court threw out the claim because the transaction had occurred overseas, New Delhi changed the law retrospectively in 2012, giving itself the power to take a part of any windfall profit on an underlying Indian asset going back to 1962. 

None of this shored up the waning credibility of Singh's government. Modi, though, weaponized the economic mismanagement to sway public opinion and the popular vote. But the non-adversarial tax regime he promised never came. Cairn, which made India's biggest onshore oil discovery in two decades, was unlucky enough to fall into the trap of retrospective taxation. And there it remains six years later, waiting for nothing more than a return of what has been forcibly taken from it.

The amount, plus interest and costs, is almost the same as the energy explorer and producer's current $1.4 billion enterprise value. It suffered this damage simply because it transferred ownership of its Indian oil field in 2006 to Cairn India Ltd., to prepare for the local unit's initial public offering. At the time, no tax was demanded. Years later, when Cairn disputed the sudden $4.3 billion levy, New Delhi expropriated its shares in Vedanta Ltd. (into which Cairn had merged its Rajasthan oil field), helped itself to the dividends and dumped the stock.

Back in 2012, India brought in retrospective taxation via the federal budget. This year's budget is due Monday. All that Finance Minister Nirmala Sitharaman has to do is to make a provision for the Cairn payment, an insignificant footnote in her $415 billion-plus expenditure plan. India should also drop the appeal against the Vodafone arbitration, which has also gone against it. By doubling down on a bad idea, the Modi government has willy-nilly made it its own and done no favors to India's business-unfriendly image. 

(Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.)

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