Cairn Energy tax dispute: How the issue unfolded

The Income Tax Department in India has slapped a $1.6 billion tax demand on British petroleum explorer, Cairn Energy.

The potentially costly claim came just ahead of the British Foreign Secretary, Philip Hammond’s two-day visit to India that began Wednesday. It has wiped off a fifth of the value of Cairn shares on Wednesday, pulling them to their lowest since October 2008. 

It all started eight years ago when Edinburgh-based Cairn Energy created a new company Cairn India in 2006 and transferred all of its India assets to it. After transferring the assets, the company listed Cairn India on the stock exchanges through an Initial Public Offer (IPO). According to Cairn, the transfer of assets was part of a reorganization exercise aimed at enabling the IPO in 2007.

In 2011, Cairn Energy sold majority stake in its Indian arm to mining giant Vedanta for $8.67 billion and still holds 10 per cent stake in Cairn India. A year later, the Congress-led United Progressive Alliance (UPA) government brought a law that sought to raise claims on past deals. The new law allowed retrospective application of capital gains tax on indirect share transfers, kicking off a series of tax claims on multinational firms leading to disputes. 

In January 2014, the tax department contacted Cairn Energy to audit its finances and weigh tax assessments for the financial year 2006-07. The company was also ordered not to sell its 10 per cent holding in Cairn India which was then valued at $1.1 billion. The tax dispute hit Cairn Energy hard and, according to media reports, has forced it to shed numerous jobs. Cairn's founder, Sir Bill Gammell, spoke of his sadness at the dispute after retiring from the board in May last year. 

The new Modi led NDA government with its massive mandate assumed office in June 2014 and Finance Minister Arun Jaitley pledged a stable and predictable tax regime in his first budget a month later. In an encouraging sign, Jaitley set up a committee to review retroactive claims and said the sovereign right of parliament to clamp retrospective taxes shall not be used to create new liabilities under the 2012 law. This came as a ray of hope for foreign investors like Cairn. 

Remember that while the I-T Department had so far not raised a tax demand on Cairn Energy, it had ordered Cairn India not to allow the transfer of UK firm's residual 10 per cent stake. The company had to lay off 100 employees as a cost cutting measure as it was unable to sell the residual stake to fund the exploration program, according to a report.

And then it happened. The tax authorities slapped the $1.6 billion (Rs 10,247 crore) claim stating the firm allegedly made capital gains of Rs 24,503.50 crore when it transferred its India business to the newly incorporated Cairn India in 2006. Tax authorities are also understood to have stated Cairn Energy received Rs 26,681.87 crore for the asset transfer against its entire investment of Rs 2,178.36 crore in the India business. 

The company has responded to the “disappointing” tax claim by filing a notice of dispute under the UK-India Investment Treaty and the two sides are now headed for a round of negotiations failing which an international arbitration panel will be constituted to adjudicate on the matter.

Cairn Energy CEO, Simon Thomson has said the company has consistently confirmed it has been fully compliant with all relevant legislation and paid all applicable taxes in India and Cairn Energy is confident of its position under the UK-India investment treaty.

“Against a backdrop of regular engagement with the Government of India since January 2014 it is very disappointing to have received a draft assessment order at this time. Since the election of the BJP, senior ministers in the government have consistently commented on the negative impact the issue of retrospective taxation has had on international reputation and investor sentiment towards India,” he said.

Thomson also said the current issue is confined to Cairn Energy’s interests in India and the group remains well funded to deliver all of its objectives and commitments and looks forward to moving with its strategy while this issue is resolved under legal process.