India Weighs Investor Protection Against Tax Sovereignty

Foreign capital inflows depend on legal protections. Bilateral Investment Treaties (BITs) (meaning: agreements between two countries that protect each other's investors) are among the most important. A BIT promises foreign investors fair and equitable treatment and protection against uncompensated expropriation. These guarantees helped make India an attractive destination for capital. But the same guarantees let foreign investors challenge India's tax decisions. In the Vodafone and Cairn Energy retrospective tax disputes, both investors won arbitration awards against the Indian government. These cases pushed India to redesign its treaty model. India had to think harder about where investor rights should end and tax sovereignty should begin.

India adopted a new 2015 Model Bilateral Investment Treaty after the Vodafone and Cairn disputes. The new model excludes taxation measures from treaty protection. This means a foreign investor cannot use investor-state arbitration to challenge a tax demand. This is not unique to India. Many countries worry about multinational firms using treaty shopping to escape tax scrutiny. The same worry drove global efforts like the Base Erosion and Profit Shifting (BEPS) framework. The OECD and G20 built BEPS to stop multinational companies from shifting profits to low-tax countries. BEPS protects a host country's tax base from erosion. Just as BEPS tries to protect a country's right to tax multinational profits, India's tax carve-out in its BITs tries to protect its sovereign right to tax. India does not want a foreign arbitration panel to second-guess its tax decisions.