Since the spread of Covid-19, the States have been dealing with many significant challenges involving public health and economic issues. Some people have lost their jobs; the companies have declared bankruptcy; the government debt has increased. In these extraordinary times, States take extraordinary measures in response to such challenges. Those measures often include temporal emergency taxation measures in order to provide incentives to the market or to increase state revenues. However, our history tells us that such temporal emergency taxation measures have caused damages to certain groups of persons or companies, and consequently investment disputes had arisen. In this paper, VCI Legal briefly explores States’ taxation measures that have been challenged by investors through Investor-State Dispute Settlement (“ISDS”).

A. Challenging Unfair Taxation Measures: ISDS Case Studies

Cairn v. India
:The retrospective imposition of corporate income tax and fair and equitable treatment

Most of the investment protection agreements (“IPAs”) impose the obligation of fair and equitable treatment (“FET”) on signatory states. The standard of FET differs in these IPAs depending on their treaty texts. Recently concluded IPAs normally make specific reference in their FET clauses such as the principle of due process or natural justice while IPAs made in the 1990s or early 2000s have no such reference. Claimant investors under these unqualified IPAs enjoy broader protection under which it is both reasonable and legitimate for investors to expect that the host state will confirm its conduct to its constitution, laws, regulations, treaties, and customary international law. In addition, if the host state fails to act consistently with the representations and benefits offered to attract foreign investment, and to unforeseeable change the essential rules of the game upon which investors relied when making the investment, this might be considered unfair and inequitable. India’s retrospective tax imposition challenged in Cairn v. India is a typical example of such unfair and inequitable treatment of foreign investors.

The transactions in issue in Cairn v. India can be seen as complicated. Cairn Energy PLC, the first claimant, is a multinational corporation of which the headquarters is located in the UK. Between 1996 and 2006, Cairn Energy PLC obtained quite a number of business interests in India’s oil and gas industry which were held by its 27 subsidiaries. None of these 27 subsidiaries was incorporated in India. In 2006, Cairn Energy PLC decided to consolidate these subsidiaries under a new publicly listed entity in India, Cairn India Ltd. After the public offering, Cairn UK Holdings Ltd, the second claimant, held 69% of Cairn India Ltd’s shares. Subsequently, a series of transactions were carried out amongst these entities, and the assets hold by the 27 overseas subsidiaries were transferred to Cairn UK Holdings Ltd, and then transferred to Cairn India Holdings Ltd, a wholly-owned subsidiary of Cairn UK Holdings Ltd incorporated in Jersey, Channel Islands, a tax haven. Finally, Cairn India Holdings Ltd was acquired by Cairn India Ltd from Cairn UK Holdings Ltd.

In early 2014, when Cairn Group was looking to sell their remaining shares in Cairn India Ltd, the Indian tax authorities began investigating the 2006 restructuring transactions. Throughout various reviews and appeal process, the Indian government imposed approximately US$1.6 billion capital gains tax on Cairn Energy in accordance with the retrospective application of the 2012 Income Tax (Amendments) Act of which one of the purposes was allegedly to aim at Cairn’s 2006 transactions.

In March 2015, Cairn Energy initiated ISDS arbitration proceedings against the taxation measures adopted by the Indian government in accordance with the India-UK bilateral investment treaty. In December 2020, the Cairn Tribunal ruled that the Indian government’s retrospective application of its Income Tax Act was in breach of FET obligation and ordered India to pay Cairn Energy about US$1.2 billion with interest for damage, US$20 million for legal costs, and US$2 million for arbitration costs.

Although the Cairn Tribunal’s reasoning for such decisions was not made public, it can be inferred from the relevant provision of the India – UK BIT. The FET standard in the India – UK BIT is a simple unqualified one under which an investor like Cairn enjoys a broad coverage of investment protection. It would be likely that the Cairn Tribunal assessed whether there was any compelling public policy beyond the retrospective application of tax law. If such an application was mainly based on increasing the state’s tax base or revenue, it is unlikely that such an application would be justified under international laws. If India could have successfully argued that Cairn’s corporate restructuring amounted to an abuse of tax evasion, the Tribunal might have accepted such argument as a legitimate justification for the retrospective application in issue. However, India did not seem to succeed on such ground. If the Tribunal had not found any legitimate justification for the retrospective application, then such measures likely amounted to conduct that is grossly unfair towards Cairn Energy.


Yukos v. Russia
: Taxation measures amounting to creeping expropriation

After the collapse of the Soviet Union, Yukos was incorporated as a joint stock company in 1993 by Presidential Decree. Fully privatized in 1995–1996, it was a vertically integrated group engaging in exploration, production, refining, marketing and distribution of crude oil, natural gas and petroleum products. In 2002, Yukos became the first Russian company to be ranked among the top ten largest oil and gas companies by market capitalisation worldwide. At its peak in 2003, Yukos had approximately 100,000 employees, 6 refineries, and a market capitalisation of US$33 billion.

Starting in 2003, the Russian government started to take a series of measures against Yukos and its management personnel mainly criminal investigation and taxation measures. The following is a summary of such measures taken by the Russian government against Yukos:

Step 1: The Russian government paralysed Yukos through criminal proceedings against shareholders of Yukos for fraud, tax evasion and embezzlement.
Step 2: A series of tax reassessments carried out by the Russian tax departments which lead to a finding that Yukos owed US$24 billion in tax.
Step 3: The Russian government seized Yukos’s shares and sold its main production subsidiary, YNG, in an auction with only one bidder, Baikal, a fake entity bought by the State-owned entity, Rosneft. YNG was sold for about half of the estimates of JP Morgan.

In 2006, Yukos was declared bankrupt. Yukos’s remaining assets were acquired by State-owned Gazprom and Rosneft, with the bankruptcy auctions raising a total of US$31.5 billion. In November 2007, Yukos was liquidated and struck off the register of legal entities.

In February 2005, Yukos initiated arbitration proceedings against Russia in accordance with the Energy Charter Treaty (“ECT”). After 10 years of proceedings, in July 2014, the Yukos Tribunal awarded Yukos US$50 billion in damages, legal fees of US$60 million, and costs of US$5.6 million. This is known to be the biggest arbitration award in ISDS history.

The Yukos case shows a typical example of indirect or “creeping” expropriation. The Tribunal ruled that the series of measures by various Russian government agencies were orchestrated by the highest levels of the Russian government. Despite the enormous size of the Tribunal’s award, the circumstances giving rise to the Tribunal’s finding of indirect expropriation have been observed in other ISDS cases. For instance, in Biloune and Marine Drive Complext Ltd v. Ghana, the tribunal found creeping expropriation on the basis of the Ghana government’s “stop work order, the demolition, the summons, the arrest, the detention, the requirement of filing assets declaration forms, and the deportation of [the investor] without the possibility of re-entry”.

What is interesting about the Yukos case in terms of taxation is the Tribunal’s assessment of the “carve-out” provision and “claw-back” provision in the relevant treaty – the ECT. The ECT contains the following provisions in relation to “carve-out” and “claw-back” of taxation measures:

Art 21(1): “… nothing in this Treaty shall create rights or impose obligations with respect to Taxation Measures of the Contracting Parties”. (carve-out provision)
Art 21(5): “[The commitment of no unlawful expropriation] shall apply to taxes …” (claw-back provision)

The Tribunal delivered two findings of which favoured the claimant investors. First, the tribunal would have “indirect” jurisdiction over the expropriation claims because any measures excluded by the carve-out provision would be brought back within the Tribunal’s jurisdiction by the claw-back provision. Second, in any event, the carve-out provision can apply only to bona fide (genuine; real) taxation actions, namely actions that are motivated by the purpose of raising general revenue for the State. With respect to the second reason, the Tribunal found that the tax assessment levied against Yukos by the Russian government were essentially aimed at paralyzing Yukos rather than collecting taxes and therefore were not exempt by the carve-out provision.

B. Implication on Vietnam

ISDS disputes against Vietnam arising from Vietnam’s taxation measures are not novel disputes. In 2012, two Vietnamese oil fields were sold by two UK subsidiaries of the US energy company, ConocoPhillips, to a UK company owned by another oil company, Perenco. ConocoPhillips made a profit of approximately US$896 million upon this transaction. In 2015, the Vietnamese government tried to impose a capital gains tax of about US$179 million on ConocoPhillips for the profit it made through this transaction. In 2017, both the seller (ConocoPhillips) and the buyer (Perenco) brought ISDS arbitration against Vietnam under the UK – Vietnam BIT on the grounds that they had no taxable presence in Vietnam. In January 2020, it became known to the public that ConocoPhillips paid an unknown amount of capital gains tax to Vietnam and withdrew the ISDS proceedings.

The ConocoPhillips case might not be an example of the State’s unfair, discriminatory or arbitrary taxation measures against foreign investors. Rather, it seems to be a paradigmatic case where a multinational company uses a loophole in one particular jurisdiction to evade its tax obligation in another jurisdiction through various investment protection agreements or tax exemption treaties. However, there are other instances in which Vietnam’s taxation measures might have increased the risk of investment disputes with foreign investors. The government’s decree regarding registration fee discount for domestically manufactured cars might be one of them.

In June 2020, the Vietnam government issued Decree No. 70/2020/ND-CP prescribing registration fees for domestically manufactured or assembled automobiles. Under this Decree, the registration fees for domestically made cars were subject to a 50% discount until 31 December 2020. In Vietnam, the car registration fees are quite expensive, amounting to 12% of the car price. Thus, this discount was a high incentive for those carmakers that have manufacturing facilities in Vietnam. On the other hand, it might be seen as discriminatory treatment of foreign carmakers that do not have manufacturing facilities in Vietnam. Despite its temporal application, these companies might have considered or possibly be still considering an action against the government if the damages to their business seem significant due to this Decree.

Please check the below link for our deeper analysis of this issue:

Taxation is the State’s core function in order to fund the government’s expenditures. Varying justifications and explanations for taxes have been offered throughout history. Various factors such as utilitarian, economic, or even moral considerations have been taken into account. However, it should be also noted that the State’s taxation measures can be subject to international adjudications if they are unfair, inequitable or discriminatory towards foreign investor.

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