AND so we thought that treaty shopping is a uniquely tax related phenomenon and Mauritius is the villain of the piece. But Vodafone has busted the myth. Away from the recent news of Vodafone's continuous parleys with the Indian tax authorities to settle its tax disputes is the fact that that Vodafone is also waging another war, this time under the India-Netherlands Bilateral Investment Protection Agreement (BIPA). Notwithstanding the fact that the North Block Mandarins have pooh- poohed the idea ever since Vodafone had threatened to invoke BIPA, it is worth considering the issue in some detail, particularly in the light of the arbitral Tribunal's decision in the case of White Industries which was kept under the wraps for some time before it surfaced in the public domain in February, 2012.

Vodafone is a British multinational. Its subsidiary, VIH BV, Netherlands had purchased a share in a Cayman Island registered company, CGP Investment (Holdings) Ltd to get hold of the Indian assets of Hutchison in India. Vodafone was asked to withhold tax from the sale consideration before making payment to Hutchison group of Hong Kong. Vodafone declined and was asked to cough up the tax involved. This is the crux of the tax dispute of Vodafone with the government of India. How does then Netherlands - Indian Investment treaty come into the picture? And what has taxation to do with investment? These are interrelated complex questions. To understand the relationship, we need to understand the nature of the bilateral investment treaties.

The decolonization process of the 1960s and 70s brought in its wake a conflict between the erstwhile colonial powers and the newly independent countries. Many of such erstwhile colonies appropriated properties that were in the first place unfairly taken away by the colonizers. There were also instances of nationalizations as well often without adequate compensation. Investor countries being mostly the same erstwhile colonial powers were obviously worried about their investments and demanded some assurance for their investments. The result was the investment protection treaties where the capital importing countries provided some domestic system of guarantee. This was followed by the bilateral investment agreements (BIT) which provided that investment related disputes should be settled by independent arbitral Tribunals.

Beginning 1990s, with the liberalization process gaining momentum and in the race for attracting foreign investments, more and more developing countries joined the bandwagon and currently there are more than 3000 BITs in place. In the race for attracting investments, developing countries are signing up more and more investment protection agreements. 1990s. Ironically, as some commentators point out, such agreements often end up putting unintended burden on the developing countries and the conclusion can be that countries have gone into signing such treaties without fully understanding the implications of the same.

India did not have any investment agreements till 1990s. At its independence, the USA had proposed India to sign an FCN treaty (Friendship, Commerce and Navigation). This was then turned down. However, with the opening up of the 90s things began to change. The first Bilateral Investment Protection Agreement (BIPA) was signed with the UK in the year 1994. Ever since, we are on a BIPA signing spree and at the last count the total number of BIPAs signed are 82 of which 72 are stated to be operational.

As in the case of a DTAA, the exact language of an investment agreement varies. However, there are certain essential features, which can very briefly be described here. Article 1 defines investment in very broad terms as asset of every kind including IPRs. Article 3 requires the contracting states to give ‘ fair and equitable treatment' to investors and to allow admission of investment in accordance with its laws. Article 4 provides for extending the national treatment and MFN treatment for investors. Article 5 of the model BIPA provides that nationalisation or expropriation may take place according to law, on a non-discriminatory basis, and with fair and equitable compensation. The most important aspect of a BIPA is the dispute settlement mechanism as contained in Article 9. It allows the foreign investor to directly take on the Indian State without first approaching its own government.

It is in this connection that the arbitration award between White Industries Australia Limited and the Republic of India should be an eye-opener for many. In this case, White Industries had entered into an agreement with the public sector company Coal India for supply of equipment and knowhow for an open cast mine. The agreement allowed for bonus for White Industries for exceeding the production target or penalty for default. Subsequently a dispute arose and Coal India encashed a bank guarantee by way of penalty. In the arbitration proceedings that ensued in ICC, White Industries won although there was a dissenting note by Justice Jeevan Reddy from India. Coal India wanted the award to be set aside and applied to the Calcutta High court and there was protracted litigation and the matter was pending before the Supreme Court. In the circumstances, White Industries brought a complaint against India for the alleged violation of the provisions of the India-Australia BIPA. The arbitration proceedings under UNCITRAL rules took place in London and the arbitrators, although did not find merit in the other charges of White Industries, nevertheless held that the Indian judicial system's inability to deal with White's jurisdictional claims for over nine years, and the Indian Supreme Court's inability to hear White's jurisdictional appeal for over five years amounted to undue delay and constituted a breach of India's voluntarily assumed obligation of providing White with ‘effective means' of asserting claims and enforcing rights.

The Tribunal therefore ordered:

“(a) The Republic of India has breached its obligation to provide” effective means of asserting claims and enforcing rights” with respect to White Industries Australia Limited's investment pursuant to Articles 4(2) of the BIT incorporating 4(5) of the India-Kuwait BIT;

(b) The Republic of India shall pay to White Industries Australia Limited the amount of A$ 4,085,180 ( payable under the award), together with interest thereon at the rate of 8% per annum from 24 March 1998 till the date of payment;

(c) The Republic of India shall pay to White Industries Australia Limited the amount of A$ 500,000 (for White's cost in the ICC arbitration), together with interest thereon at the rate of 8% per annum from 24 th March 1998 until the date of payment….”

The worrying aspect of the case is that it was a dispute between two private parties; yet, the government of India was ordered to pay compensation to a private party. This was not even a case of investment in the sense in which it investment is ordinarily understood but a commercial transaction of supply of machineries and knowhow. Moreover, as commentators have pointed out, considering the normal delays in India's justice delivery system, the case may open the floodgates for similar claims against the Government of India by others. It is obvious that ‘investment' has been very expansively defined in such agreements so much so that even an arbitration award has been considered as an ‘investment'.

The expansive definition of ‘investment' also leads to treaty shopping and situations where the citizens of the host Country themselves can attempt to take advantage of such BITs much like the round tripping resorted to in the case of DTAAs. One example from an arbitral tribunal ruling will be illuminating. In Tokios Tokeles V Ukraine, a Lithuanian company brought a claim against Ukrainian government for breaching certain BIT obligations. Ukraine asserted that Ukrainian nationals in fact owned Tokios and that to find justification in this case would tantamount to allowing Ukrainian national to pursue international arbitration against their own government! The majority of the Tribunal nevertheless ruled in favour of Tokios basing the decision on the definition ‘investor' as used in the treaty – an investor was defined as an entity established in the territory of the republic of Lithuania in conformity with its laws and regulations. The Tribunal held that since the Lithuanian company was created six years prior to the entry into force of the relevant BIT, it was not evident that there was an improper use of the BIT.

One more interesting factoid relating to investment treaties and claims in arbitration proceedings is the fact that there was roughly 400 such claims in 2011. Out of this, 41 cases or roughly 10% of the total was involving the Netherlands. And, out of this in 29 cases, the ultimate controlling parent was not based in the Netherlands and 25 of them had no employees at all on their payroll. These were all shell companies with no substantial activity in the Netherlands. [Source: Dutch Bilateral Investment Treaties- A gateway to ‘treaty shopping' for investment protection by multinational companies- Roos Van Os&Roeline Knotttnerus]

The purpose of this article, however, is to see the interaction between BIPA and DTAA considering Vodafone's threatened action against the government. In this connection, it may be useful to have a look at the provision in Article 4 of India-Netherlands:

“National Treatment and Most-Favoured-Nation Treatment

(l) Investments of investors of each Contracting Party shall at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other Contracting Party.

(2) Each Contracting Party shall accord to such investments, including their operation, management, maintenance, use, enjoyment or disposal by such investors, treatment which shall not be less favourable than that accorded either to investments of its own investors or to investments of investors of any third State, whichever is more favourable to the investor concerned.

(3) The provisions of paragraphs l and 2 in respect of the grant of most favoured nation treatment shall not apply to privileges which either Contracting Party accord to investors of third States on account of its membership of, or association with, a customs or economic union, a common market or a free trade area.

(4) The provisions paragraphs 1 and 2 in respect of the grant of national treatment and most favoured nation treatment shall also not apply in respect of any international agreement or arrangement relating wholly or mainly to taxation or any domestic legislation or arrangements consequent to such legislation relating wholly or mainly to taxation.

(5) Each Contracting Party shall observe any obligation it may have entered into with regard to investments of investors of the other Contracting Party. Provided that dispute resolution under Article 9 of this Agreement shall only be applicable in the absence of a normal, local, judicial remedy being available. ” (Emphasis supplied)

It is with reference to this provision that the Ministry of Finance officials seem to have reacted to the claim of Vodafone. In this connection, it may be noted that there are various options of excluding the taxation matters from a BIT. There can be a specific exclusion through a national treatment or MFN provision. In the model BIPA, India seems to be following this approach. However, there may be tax questions having a bearing on other rights of the investors as granted in the agreement and these would not be dealt with in the above approach.

Secondly, there could be qualified exclusion of tax matters and the use of tax measures as a means of expropriation may be prohibited. However, as UNCTAD suggests [UNCTAD/ITE/IIT/16] countries wishing to avoid linking tax and investment issues should take recourse to a general exclusion clause to the effect that taxation issues are completely excluded from BIPA. However, this provision may also get nullified because of the MFN clause of an agreement. Therefore the ideal will be to have a general exclusion for taxation measures together with particular exclusion of such measures from MFN/national treatment obligations. Care has also to be taken to ensure that because of the MFN clause, those who were not parties to a DTAA treaty should do not take tax treaty benefits.

It is well known that modern day DTAAs owe their origin to the OECD. What is less well known is that even the BITs also owe their origin to the OECD. The first draft of Investor protection Agreements, which were the precursor of the BITs, also originated in the OECD. There are therefore certain structural similarities although it must be understood that in the beginning the DTAAs were essentially between the developed countries whereas BITs started as a compact between capital exporting and capital importing nations.

In this context, it is interesting to note that the OECD commentary has indeed foreseen a conflict between a DTAA and certain other agreements notably GATT. As is well known, disputes between the contracting states in the matter of taxation is covered by the mutual agreement procedure in terms of Article 25 of the OECD/UN Model. In the commentary to Article 25, referring to Article XXII of GATS to the effect that a national treatment rule under Article XVII may not be dealt with under the dispute resolution mechanism of GATS if the disputed measure falls within the scope of international agreement relating to avoidance of double taxation, the commentary says that the expression ‘falls within the scope' is a vague expression and urges the adoption of a provision to the effect that any doubt as to the interpretation in this regard shall be resolved under paragraph 3 of Article 25. The OECD commentary then states: “Problems similar to those discussed above may arise with other bilateral or multilateral agreements related to trade or investment. Contracting States are free, in the course of their bilateral negotiations, to amend the provisions suggested above so as to ensure that issues relating to taxes covered by the convention are dealt with through the mutual agreement procedure rather than through the dispute settlement mechanism of such agreements.”

The double tax treaty with Netherlands has very recently been renegotiated mainly to bring the Exchange of information clause in conformity with the latest standard. However, considering the fact that Vodafone is considering arbitration under the BIPA, it would have been desirable to include a clarification in the renegotiated DTAA as suggested in the OECD commentary itself.

As I write this, there is a news report in today's Hindu to the effect that the Government has put on hold all BIPA talks- (BIPA talks put on hold- Hindu Jan 22, 2013). This is a sensible decision. Foreign investment can be attracted in many ways. The vast Indian market is in itself a sufficient incentive for investors seeking opportunities. In fact, one of the emerging economies, Brazil so far has not ratified a single BIT and yet receives plenty of foreign investments. We should not go on entering into treaties just because the same is in fashion at the moment without fully understanding the implications. In the very least, there should be a separate carve out for taxation matters in BIPAs and our DTAAs should reinforce the same by specifically mentioning that taxation matters between the countries involved shall be resolved only within the framework of the DTAAs.