A BIT for FDI

Reading down the draconian retrospective tax law gives the government the opportunity to renew the 70-odd Bilateral Investment and Protection Agreements mothballed since 2017

With Parliament putting the ghost of retrospective tax to rest on August 9, India can now bring out the 70-odd Bilateral Investment Promotion and Protection Agreements (BIPA), mothballed since 2017, for renewal. Several law firms representing interests of companies abroad hope this will happen soon.

The hope is not misplaced even though some new complications have emerged in the years since Parliament passed the retrospective tax in 2012. One of those is reconciling definitions of investment under BIPA or Bilateral Investment Treaty (BIT), to use their official name in India, to include assets in addition to that of enterprises. The other is that of national treatment.

India has never been comfortable recognising investments from abroad when they are asset-based. In other words, buying a company in India— brownfield investment — is not something for which the BIPA was designed. It sought to promote an “enterprise” based definition —greenfield investment as a more suitable example of foreign direct investment (FDI).

The other is that of “national treatment”, which the department of economic affairs in the finance ministry notes, should be the “sole non-discrimination standard to be applied to all companies investing in India”. To qualify for it, however, companies have to demonstrate they have a permanent business establishment in India, as well as agree to some new yardsticks such as data localisation and sourcing requirements.

If they do not do so, there could still be problems for investors to invoke BIPA or BIT to protect their interests.

The concept of BIPA is like insurance. Countries assure foreign investors when inviting their investment that their administrations will provide tax certainty. If that certainty comes unstuck, BIPA comes into play. China, for instance, does not have a BIPA and there are several countries with such agreements that do not draw in money from abroad.

So the best BIPAS are those that, in effect, do not need to be invoked. Besides being costly, the publicity surrounding the action makes foreign investors nervous. Also, new options are now available to investors to avoid having to live under a BIPA. India discovered this fact once it had begun with attempts to enter global bond indices. Fund managers for foreign investors have said India has to list its government debt papers in European depositories such as Clearstream and Euroclear. Paper listed on these depositories is bought and sold in convertible foreign exchange and the issuing governments have to freeze their tax treatment on them. The process helps investors avoid exchange or tax losses. India is moving in this direction and hopes to settle the negotiations before the end of this calendar year.

Despite these innovations, BIPA retains its importance for investors who buy or develop physical assets in India. The problem is that India since 2012 has made its BIT regime tough.

The Model BIT of 2016 inserted clauses that tilt strongly in favour of the sovereign. Among its stipulations: The treaty will not apply to “any law or measure regarding taxation, including measures taken to enforce taxation obligations”. This is why partner countries have baulked at signing the new agreements once the older ones lapsed. So no BIPA has been renewed since 2017 when most of them expired.

There is some history to these developments. From 1993, India began to sign a raft of International Investment Agreements, mostly with OECD countries. Little importance was attached to the legal intricacies and consequences of these agreements, since India needed the foreign money. In 2011, there was an award by an international arbitrator under one of these agreements in a case between White Industries of Australia and Coal India. White Industries was a mine development operator for Coal India. The dispute was over how much payment White should get for its services, with claims and counterclaims about quality of work, issues of bonus and penalties. The arbitration went in favour of the Australian firm.

Stung by the award, in July 2012, the government set up a committee to review these agreements. It asked for a uniform BITS regime that India should adopt with all countries. But as a report by the United Nations Conference on Trade and Development noted, the new framework was not designed “as an instrument for investment promotion”. India’s model BIT contained the longest chapter in the world on settlement of disputes. There were 18 articles in the chapter, far longer than any BIT written by any country.

“Evidently, this chapter was drafted to

safeguard India as a host State from the large number of investment treaty claims it has been facing since White Industries,” noted a research paper from Nishith Desai Associates, one of India’s premier law firms. The model BIT neatly sat with the retrospective law, passed in 2012, that allowed the government to tax, with retrospective effect, indirect transfers of an Indian capital asset, even if it was done as part of a sale of a company abroad.

Foreign investors have always argued that the rights of punitive taxation written in the BIT are akin to expropriation. So there should be safeguards. The Indian tax department had argued there can be no restriction in its power of taxation. The BIT incorporated the tax department’s point of view, therefore diluting the concept of expropriation. The environment was so adverse that the finance ministry had to accept it would not be able to convince any country that its investments will not fall foul of Indian tax laws and the amended BIT will give no relief in domestic courts. By 2018, India had the largest number of international arbitration cases — 15 — among any country.

Now with both houses of Parliament having passed the Taxation Laws (Amendment) Bill, 2021, the BIT framework has the opportunity to be thoroughly reworked. This exercise would, however, imply circumscribing the rights of the tax department, which would raise a whole new set of challenges.