Author name: CBCL

Unwrapping the Conundrum: The Vodafone-India Tax Saga

Arbitration Law, Contemporary Issues, Taxation Law /

[By Urja Dhapre and Chetan Saxena] The authors are students at the Institute of Law Nirma University. Introduction In an attempt to draw things to a close, the Permanent Court of Arbitration [PCA] has passed an award against India’s Income Tax Department, upholding Vodafone International Holding BV’s [VIH] claims to not pay the tax liability for a whopping $2.2 billion. The award holds the Indian Tax Department to be in violation of Article 4(1) of the Bilateral Investment Treaty [BIT] between India and the Netherland which elucidates the principle of fair and equitable treatment to the investors. VIH’s saga of a tax dispute in India dates back to the year 2007 wherein a tax liability was imposed on VIH by India’s Tax Department alleging VIH to have concluded its acquisition with Caymanian-based CGP Investments from Hutchison Telecommunications International Ltd [HTIL] based in Hong Kong as a colorable device to ultimately get a controlling interest in Hutchison Essar Ltd [HEL], an Indian company whose control was held by CGP Investments. While the Bombay High Court [BHC] ruled in favor of the tax department, the Supreme Court [SC] overturned the BHC’s judgment by clarifying that the transaction in contention was not related to the transfer of an asset but rather the transfer of a share. VIH’s resort to International arbitration rests on the grounds of a retrospective amendment in the Income Tax Act, 1961 [IT Act]by the government in 2012, such that it overturned the Supreme Court of India’s [SC] judgment, making VIH labile for tax dues. Offshore Indirect Transfers and their Taxation Aspects Offshore indirect transfers [‘OITs’] like the one of VIH-Hutch, are one such category of transactions that are viewed to have built to abuse the tax regulations of a country, such that the ownership and effective control of an asset is transferred without replacing its legal owner. The underlying asset does not change hands, so there is formally no capital gain directly realized. However, gains are made out of such underlying assets even though the primary ownership remains the same. The chargeability of such gains is thus contested due to its uncertainty in interpreting OITs and their taxation with no standard regulations set across the globe. In June 2020, the Platform for Collaboration on Tax [PCT] came up with a report concluding that location countries shall have the right tax OIT’s. However, an important deliberation was of the inclusion of specific provisions taxing the OIT’s. While the report transcripts the view that OITs shall be taxable where the underlying asset lies, it refrains from the applicability of such taxes retrospectively. The Retrospective Amendment and its Validity The amendment brought forward by the Government of India overturning the decision of the SC disrupts the entire affixed jurisprudence of tax statutes in India. The aspect of retrospectively amending tax clauses for the sole purposes of overturning the judgment has been questioned and its condemnation has been widely unveiled through a catena of judgments. In the case CIT v. NGC Networks (India) Pvt. Ltd., BHC applied the principle of lex non cogit ad impossibilia (the law does not compel a man to do what he cannot possibly perform) with respect to the contested retrospective amendment of Explanation 6 to Section 9(1)(vi) of the IT Act. Moreover, the Indian Tax Authority [ITAT] in the case of Cairn India Ltd &Ors. v. Government of India (post the Vodafone ruling) had held that the assessee cannot be burdened with the levy of interest where it could not have visualized its tax liability at the time of the transaction, and tacitly lent credence to the view that the indirect transfer provisions were new and did not previously exist. The approach of the SC with respect to retrospective amendments is also very unambiguous. In the case of Commissioner of IT, New Delhi v. Vatika Township Private Ltd the court observed that taxing principles should be construed in their strict interpretation, and ordinarily, a statute should not be held to have a retrospective effect. Anything contrary breaches the principles of natural justice along with it being violative of the right to carry trade under Article 19(1)(g) of the Constitution of India. Another bench of the SC, held on similar lines, clarifying “the Legislature cannot set at naught the judgments which have been pronounced by amending the law, not for the purpose of making corrections or removing anomalies but to bring in new provisions which did not exist earlier.” Principle of Fair and Equitable Treatment and Offshore Indirect Transfer The principle of fair and equitable treatment [FET] is one of the most accustomed provisions often found in Bilateral Investment Treaties [BITs], casting an obligation on the host countries to provide foreign investors with a fair and equitable treatment. A lot of discussion has evolved to interpret the minimum standard of the FETs as to whether it is a self-contained standard, referring to general International Law which has to be interpreted in each case by the arbitrators or it should be linked to customary international minimum standard. To resist a blurred and ambiguous situation, the tribunals have analyzed five categories of elements to be encompassed to interpret this principle: Obligation of vigilance and protection, Due process including non-denial of justice and lack of arbitrariness, Transparency, Good faith – which could include transparency and lack of arbitrariness and Autonomous fairness elements. Analyzing the tribunal’s decision to be against the fair and equitable principle accorded in Article 4(1) of the India-Netherlands BIT, the authors attempt to study in the light of international jurisprudence the approach that tribunals have undertaken in similar cases. One such remarkable case is of the Occidental Exploration and Production Company [OEPC] initiating arbitral proceedings against Ecuador for violating the FET provision of their BIT. The Tribunal interpreted the FET standard to require the “stability of legal and business framework” to be met with the transaction. It concluded that the framework, under which the investment had been made and operated, was altered to a crucial extent by amending its

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Amendment to the IBBI (Liquidation Process) Regulations

Insolvency Law /

[By Arushi Gupta] The author is a student at the National Law University, Odisha. The Insolvency and Bankruptcy Board of India (hereinafter ‘IBBI’) in a press release dated November 13, 2020, has notified the Insolvency and Bankruptcy Board of India (Liquidation Process)(Fourth Amendment) Regulations, 2020 (hereinafter ‘the Amendment’). The amendment enables the liquidator to assign or transfer a ‘not readily realizable asset’ (hereinafter referred to as ‘NRRA’) to any person after due consultation with the stakeholders’ consultation committee.[1]The article aims to discuss the backdrop and possible implications of the amendment. Background The amendment has been introduced to address the concerns with respect to the increasing delays in the liquidation process due to the non-realization of certain assets that are uncertain in nature and the realization of which takes time longer than the usual time frame for the realization of other assets. These concerns were first highlighted by the report of the Bankruptcy Law Reforms Committee which while contemplating upon the “Rules to close the liquidation” for the code, discussed the issues regarding the probability of recoveries of certain assets forming part of the liquidation estate in the future (i.e after the end of the liquidation). The committee was of the view that the liquidator must close down the case with the permission of the adjudicating authority and create a trust wherein the recoveries would be deposited. Subsequently, due to the rising number of corporate insolvency cases with a long-drawn liquidation process leading to a reduction in the realizable value of such assets, a discussion paper on the Corporate Liquidation Process was floated by the IBBI to address the aforementioned issue. The discussion paper discusses in detail the need for the amendment and the framework for the same. The discussion has also been substantiated with the examples of various International Practices[2] and statutory provisions[3] in the Indian realm, wherein assignment of a cause of action to a third party is allowed. Rationale The code basically envisages the timely completion of the liquidation process so as to ensure that the assets of the Corporate Debtor can be put to use for alternate purposes. As per regulation 44(1) of the IBBI (Liquidation Process) Regulations, 2016, the liquidator is required to liquidate the corporate debtor within a period of one year from the date of commencement of the liquidation.[4] However, the presence of NRRA in the liquidation estate leads to delays due to the uncertain nature of the asset and the indefinite period involved for the conversion of such assets into cash. An NRRA has been defined as any asset which is included in the liquidation asset and includes contingent or disputed assets, and assets underlying proceedings for preferential, undervalued, extortionate credit, and fraudulent transactions.[5] Before the amendment came into the picture, two scenarios could be envisaged: In case of dissolution of the Corporate debtor without realization of the NRRA, the assets would be left unrealized and in an undistributed state. Furthermore, the stakeholders would be deprived of their due recovery leading to the interests of such stakeholders being compromised; or In case the dissolution is kept pending for the purposes of realization of the value of NRRA, it would lead to mounting expenses of the liquidation process and also lead to depreciation of the value of an asset over the pending time period. Furthermore, the liquidator would have to arrange for monetary resources (i.e. funds) to suffice for the costs associated with legal proceedings. Additionally, considering the delay involved in the litigation, the liquidation process might extend beyond the timelines and hence defeat the entire object of timely completion of the liquidation process. In order to address the above-mentioned concerns, the amendment has been introduced. The amendment essentially aims at enabling the liquidator to assign or transfer an NRRA to any person in consultation with the stakeholders’ consultation committee. It is to be noted here that the liquidator must first attempt to sell the assets. In case of failure to sell, the asset may be assigned or transferred to any person after consultation. In a scenario where both the remedies fail, the undisposed assets would be distributed amongst the stakeholders with approval from the Adjudicating Authority. Analysis The discussion paper while contemplating upon the amendment discusses in detail the concept of assignment of rights and cause of action. With respect to assignment, in the case of ICICI bank Ltd. v Official Liquidator of APS Star India Ltd.[6], the Supreme Court held that “rights under a contract are always assignable unless the contract is personal in its nature or unless the rights are incapable of assignment, either under the law or under an agreement between the parties”. Hence assignment may be denied on the grounds of (a) a provision in the respective law barring the assignment, or (b) an agreement between the parties placing a restriction on assignment. It is to be noted that the entire discussion upon the assignment and the framework proposed by IBBI does not deal with the consequences or possible alternatives in a case where the agreement between the parties places a bar on assignment. Furthermore, another point of consideration that arises is that there is no express provision in the Code that bars or allows such assignment in the liquidation process. While the code does allow the creditors to assign their claims or interest in favor of the third parties at the resolution stage, there is no such right that has explicitly provided at the liquidation stage. Considering the fact that time is the essence in the liquidation processes, the amendment would serve a dual purpose of ensuring the maximum realization of the NRRA and the closure of the liquidation process within the specified timelines. Furthermore, this move would also lead to the creation of a new market for these assets and consequently better utilization of such assets. Endnotes: [1] https://ibbi.gov.in//uploads/press/2020-11-13-220539-eb6yn-50277513bcc7d94092ce4ee2b6591aad.pdf [2] Practices of UK, Australia, Hongkong and Singapore [3] Transfer of Property Act, Section 132; Code of Civil Procedure, Order XXV [4] IBBI(Liquidation Process) Regulations, 2016, Regulation

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A Case for Buy-Back Agreements under the IBC

Insolvency Law /

[By Anjali Soni] The author is a student at the National Law University, Odisha. Introduction Real estate developers use various mechanisms to raise finance apart from the traditional loans received from Financial Institutions and buy-back agreements are one of such instruments. Buyback schemes are where the developers agree to repurchase the property at a higher price, within a stipulated time, during which the homebuyers generally get some percentage of annual returns. Such offers are usually undertaken to encourage sales. Even though the homebuyers were declared as financial creditors so far as the Insolvency and Bankruptcy Code is concerned, however, homebuyers categorized as speculative investors have no remedy under the IBC. The NCLAT recently in the case of  Shubha Sharma, Suspended Board of Director v. Mansi Brar Fernandes ruled that homebuyers with a compulsory buy-back agreement are not genuine buyers but mere speculative investors and hence cannot seek relief under the provisions of the IBC. This article seeks to analyze the judgment and make a case for investors under buy-back agreements. Facts Gayatri Infra Planner Pvt. Ltd. Company, a real estate developer, and Mrs. Mansi Brar Fernandes entered into an agreement/MoU for the provisional allotment of four apartments in a project named “Gayatri Life”. Rs. 35 lacs was paid by the financial creditor at the time of signing the agreement. The agreement had a compulsory buy-back provision which stipulated that upon the expiry of 12 months, the Corporate Debtor was to return the initial amount along with an additional Rs. 65 lacs as premium, failing which the homebuyer was to take possession of the apartments. The Corporate Debtor issued two post-dated cheques in favor of the financial creditor. Upon inquiring, the Corporate Debtor expressed his interest to exercise the buyback but the said cheques were dishonored upon encashment. No amount was returned after repeated extensions nor the possession of the apartments was given. The financial creditor finally filed the application under Section 7 of the IBC. Decision of the adjudicating authority The two primary objections raised before the Adjudicating Authority. First, that the allottee does not come under the definition of Financial creditor, and second, that the amount of default is Rs. 35 lacs and not Rs. 1,02,50,000 as claimed by the allottee. The NCLT did not accept either of the objections and admitted the application on the grounds of the debt being a financial debt in view of the explanation inserted under clause Section 5(8)(f) by the Insolvency and Bankruptcy (Second Amendment) Act, 2018. Aggrieved by this order, the former Director of the Corporate Debtor filed an appeal before the Appellate Tribunal. Decision of the Appellate Tribunal The Honourable Appellate Tribunal while setting aside the impugned order ruled that the MoU signed by the financial creditor and the real estate developer is an agreement to buy back the apartments and not an agreement for sale of the apartments. Since the buyback is an irrevocable and compulsory buy-back agreement, the homebuyer is actually a speculative investor and not a genuine homebuyer. Judicial precedents regarding homebuyers with a buy-back agreement under IBC In the case of Kussum Chadha v. C&C Towers Ltd. the real estate developer launched a ‘Buy Back’ scheme inviting investors but defaulted in payment of the assured monthly returns to financial creditors. Cheques issued in favor of the financial creditors towards the refund and premium due were dishonored, and the CIRP petition was admitted by the NCLT. Similarly, in the case of Narender Kumar v. Aadinath Probuild a buy-back agreement cum guarantee deed was executed in favor of the applicant and after the default in payment, CIRP proceedings were initiated. The Adjudicating Authority categorically laid down that since the amount of money has been raised under a real estate project, it has the commercial effect of a borrowing and comes within the scope of a financial debt. Analysis of the nature of debt under a buy-back agreement In the author’s opinion, homebuyers under a compulsory buy-back agreement should be considered as financial creditors because the debt owed to them fulfills all the prerequisites of a financial debt. Section 5(8) of the IBC provides two primary components for a debt to be classified as a financial debt. First, the debt has to be disbursed against the consideration for the ‘time value of money’ and second, the transaction should fall under any clauses between (a) to (i). The NCLAT in the case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd ruled that the first essential requirement of financial debt has to be that the debt is disbursed against the consideration for the time value of money. Black’s Law Dictionary defines ‘time value’ as “the price associated with the length of time that an investor must wait until an investment matures or the related income is earned”. Essentially, the time value of money is the incentive that the said investor gets after a stipulated time period against the investment. Under buy-back agreements, the real-estate developers give lucrative offers to investors in order to stimulate sales. These offers include assured annual returns at attractive rates and heavy premiums along with the principal amount after the time period is over. The time value of money in such transactions is evident from the monetary benefits received by such investors. With regard to the second requirement, a debt can be classified as a financial debt if it is raised under any transaction having the commercial effect of a borrowing as mentioned in Section 5(8)(f) of IBC. The Hon’ble the Appellate Tribunal in the case of Rajendra Kumar Saxena v. Earth Gracia Buildcon Pvt. Ltd. held that the explanation inserted under Section 5(8)(f) states that any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing, making all allottees of real estate as ‘financial creditors’. Finances raised under a buy-back agreement also have the same commercial effect of a borrowing. During times of financial crises, real estate developers resort to raising funds through buy-back agreements

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Homebuyer Decree Holder as Financial Creditor: The Never-Ending Debate

Insolvency Law /

[By Nikhil Singh] The author is a student at the National University of Juridical Sciences, Kolkata. Introduction The Insolvency and Bankruptcy Code, 2016 (“Code”) was brought with an intent to secure the creditors’ interests by providing exhaustive provisions for corporate restructuring and debt recovery. Creditors are classified into two heads i.e. financial and operational creditors and the process to initiate a corporate insolvency resolution process (“CIRP”) has been provided in the Code. The phrase “creditor” has also been defined in the code itself under Section 2(10). The definition expressly includes “decree holder” within the scope of the term. As regards the homebuyers, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 put them in a priority position by including the amount advanced by them to the builders within the definition of “financial debt” under Section 5(8)(f) of the Code. The Supreme Court has also held that the remedies under Real Estate (Regulation and Development) Act, 2016 (“RERA”) and the Code co-exist with concurrent remedies under the two statutes. However, a recent ruling by the National Company Law Appellate Tribunal (“NCLAT”) has raised a debate as to whether a decree holding homebuyer would be covered within the definition. Analysis In Sushil Ansal v Ashok Tripathi (“Sushil Ansal Case”), the respondent i.e. the homebuyer had purchased a flat from the appellants and paid a certain amount in relation to it. Upon the appellant’s failure to deliver possession, the respondent got a recovery certificate i.e. decree in his favour from the Real Estate Regulatory Authority. After this, he initiated CIRP under Section 7 claiming himself as a decree-holder, and not a homebuyer. Now based on the facts of the case, it was clear that there was no dispute as to the existence of the debt and even the appellants did not challenge this. The only contention raised by the appellant was that once the respondent became a decree-holder, the underlying builder buyer contract stood terminated and thus no CIRP could be initiated based on it. Now a question arises as to whether a decree-holder ceases to be a financial creditor who can imitate a CIRP under Section 7. On this point, there are contradicting positions taken by the courts. In the case of Urgo Capital Ltd. v Bangalore Dehydration and Drying Equipment Co.(“Urgo Case”) the court had ruled in the positive holding that a decree-holder continues to be a financial creditor and can consequently initiate a CIRP under Section 7. The court had further clarified that just because the claimant does not go for court execution of the decree, it does not disqualify him from initiating CIRP based on the decree. Further jurisprudence on Section 7 is that the claimant only needs to show the existence of creditor-debtor relations by proving the existence of a debt. More specifically, the court had allowed section 7 application stating that as long as the amount under the decree has not been paid, the debt exists and that the decree itself will be evidence of the existence of a debt. Now, a parallel to money decree can be drawn from arbitral awards passed by tribunals. The position taken by the court in K Kishan v Vijay Nirman Co. was that an award- the creditor is considered as a financial creditor who can initiate a CIRP based on the award. The only condition is that the timeline to challenge the award under Section 34 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) has elapsed. This analogy is further strengthened by Section 36 of the Arbitration Act, which states that an award is to be enforced as if “it is a decree of a court”. Now, one might rightly argue that if an arbitral award is kept on the same pedestal as a court decree, the Code and NCLAT cannot treat them differently to establish the creditor-debtor relations. The NCLAT had done the same mistake in the heavily criticized judgment in Digamber Bhondwen v. JM Financial Asset Reconstruction Company (“Digamber”). There, the Tribunal had taken an erroneous position in holding that a decree-holder, although falling under the definition of a creditor under section 3(10) of the Code, will not be entitled to file an application under section 7 or section 9 of the Code as the definition of a ‘financial creditor’ or an ‘operational creditor’ does not include a decree-holder. Such a position is flawed because it would invalidate the definition of the term “creditor” itself. If decree-holder has been expressly included in the scope of creditor, and judicial precedents have appreciated such inclusion, the position in Digamber would not only be in conflict with the legislative intent but also its own position in previous judgements. Now although a larger bench in the Urgo Case has contradicted this and taken the correct position, the judgement has not been overruled and has made way for the larger bench decision in the Sushil Ansal Case. Thus, currently, these two judgements stand in contradiction with each other and as both are of the same bench strength, none of them have overruled the other. This has created a gap on this issue which can only be settled by a larger bench of the NCLAT or the Supreme Court of India. Another, problem that the exclusionary position creates is that the decree holding homebuyers are now left remediless under the Code. Explanation II of Section 5(8) categorically includes the amount raised through a builder buyer contract as a “financial debt” enabling homebuyers to initiate CIRP as financial creditors under Section 7. Now it is true that the basis of the creditor-debtor relation is the builder buyer contract and that once a decree is passed based on such a contract, the contract stands terminated. However, this basis is only relevant to prove the existence of the debt and once a decree is passed based on such a contract, the decree itself becomes evidence of the debt if there is no appeal against it. The NCLAT seems to have failed in analysing this point in

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WhatsApp Pay: The ‘One-Stop Shop’ CCI DIDN’T STOP

Competition Law /

[By Shivek Sahai Endlaw and Tanya Aggarwal] The authors are students at Amity Law School Delhi, GGSIPU. Introduction In November 2020, WhatsApp announced the rollout of their new Unified Payments Interface (‘UPI’) enabled digital payments feature, ‘WhatsApp Pay’ in India. WhatsApp Pay will allow the users of WhatsApp messenger to send and receive monetary payments to their contacts, in addition to the existing instant-messaging, phone, and video–calling services. This feature will be automatically installed in the existing user’s WhatsApp Messenger and will come pre-installed as part of the WhatsApp messenger for all new and future users. The manner in which these two distinct services are offered as part of one application raises certain anti-competitive concerns. An information was filed before the Competition Commission of India (‘CCI’) accusing WhatsApp of technically tying its messenger services with its new payments feature. Technical tying refers to a process where a dominant entity offering a product (‘tying product’) integrates it with a separate and distinct product (‘tied product’) in order to gain an advantage in the ‘tied products’ market. Such an arrangement is prohibited by Section 4(2)(d) of the Competition Act, 2002 (‘Act’) as it can have an adverse impact on competition in the tied product’s market. The CCI ruled in favour of WhatsApp and refused to investigate these allegations for being premature among other reasons. In this post, the authors argue that a case of technical tying against WhatsApp is justified. Further, the authors argue that the decision of the CCI was contrary to anti-trust jurisprudence related to tying in other developed jurisdictions. Test to Establish Technical Tying  In order to establish a case of technical tying, a regulator must be satisfied that (i) the tied products are two separate products (ii) the offeror is dominant in the market for the tying product; (iii) customers do not have a choice to only obtain the tying product independently of the tied product; and  (iv) the arrangement can have anti-competitive effects in the market. The CCI held that the “market for Over-The-Top (OTT) messaging apps through smartphones” and the “market for UPI enabled Digital Payments Apps in India” are separate and hence the two services being offered by WhatsApp constitute two separate products. Further, the CCI held that though WhatsApp is a dominant entity in the market for OTT messaging applications, the other two conditions were not satisfied and hence a case of technical tying was not made. According to the authors, the CCI erred in holding that the third and fourth conditions to establish a case of anti-competitive tying are not met. Users Choice to Obtain the Tying Product Independently  The third condition to prove a case of technical tying states that customers should not have a choice of obtaining the tying product without the tied product. The CCI held that this condition is not met, since WhatsApp users are free to use any other UPI enabled digital payments applications available in India. The CCI reasoned that the element of coercion was missing since installing the WhatsApp messenger services does not mandate the consumer to use WhatsApp Pay exclusively. The reasoning afforded by the CCI for rejecting the presence of the third condition is flawed for two reasons. First, the CCI incorrectly applied the test to detect the presence of the third condition. The correct application to test the presence of the third condition is explained by the European Commission (‘EC’) in the Microsoft Windows Media Player case (COMP/C-3/37.792). In this case, the EC held that the third condition is met once the regulator is satisfied that the tying product is not available for purchase de hors the acquisition of the tied product. This aspect was not examined by the CCI. In the present case, the WhatsApp Pay feature has been automatically installed for all existing users of WhatsApp messenger and will come pre-installed as part of WhatsApp messenger application for all new users. Both the primary application stores from which the WhatsApp messenger can be downloaded/updated do not offer the messaging and the payment products separately. Therefore, the consumer is indeed forced to purchase the two products together and not independently. This satisfies the presence of the third condition to establish a case of tying. Second, the CCI erred by rejecting the presence of this condition basis the lack of coercion on consumers to use the payment feature. The rationale behind this is explained by the Court of First Instance in the Microsoft Internet Explorer Case (Case T-201/04). According to the Court, it is irrelevant whether the users are forced or coerced to use the tied product. This is because the automatic or free availability of the tied product itself has the capability to foreclose competition in the tied product’s market. Therefore, the regulator should only assess whether the consumers of the tied product are likely to use the tied product over the other similar products of competitors due to the technical tying arrangement. In the present case, the CCI should have investigated the possible foreclosure of competition in the digital payments market due to the automatic availability of WhatsApp Pay to millions of people who use the WhatsApp messenger. However, this aspect was also not examined by the CCI. Thus, the authors opine that the CCI erred in holding that the third condition to establish a case of tying was not met. The Tying Arrangement Can Have Anti-Competitive Effects in the UPI Market  The fourth condition to establish a case of tying states that the tying arrangement can have an anti-competitive effect in the tied product’s market. The CCI held that this condition was not met since there is a status-quo bias in favour of the incumbent UPI enabled digital payment applications like Google Pay, Paytm, Phone Pay, Amazon Pay. Status-quo bias is the propensity to stay the course instead of doing something different. Further, the CCI held that since the WhatsApp Pay feature was currently operating in beta version in India, the information furnished was premature and hence liable to

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A Self Regulatory dharmsankat: An Outlook on The Future of Fintech Through RBI’s SRO Policy

Contemporary Issues /

[By Adarsh Vijayakumaran] The author is a student at the National University of Advanced Legal Studies, Kerala. In the last few years, financial technology (or FinTech) has revamped the working of finance in India’s evolving legal system. It has changed the landscape of traditional investment instruments and brought newer fleshier techier tools and varieties at the same time, making finance look simple and faster. While for sometime FinTech instrument remained people’s favorite romp, the news of alleged data leaks in Google Pay and the great Indian crypto Ponzi schemes have created a challenging picture for the working of FinTech, thereby, calling forth the regulators of all kinds to regulate these hagfishes to protect the innocent investors. It was in light of this huge stakeholder outcry that on October 22, 2020, the Reserve Bank of India (RBI) exercised its powers under the Payment and Settlements Act, 2007 to introduce a framework for the recognition of Self Regulatory Organization (SRO) for payment system operators. But a question that needs to be answered is if self-regulation, the most viable option for regulating FinTech? More so, if the RBI’s present policy (even though at its nascent stage) will adequately address the risks and concerns that FinTech since its inception possessed? And finally If not SRO, then what should be next? Self-regulation represents a social organization whose origin could be traced back to the ancient time of medieval guilds, and merchants were a group of men joined together to form a pact envisaging their rights and obligations. In today’s world, self-regulatory bodies exist in different fields including law, medicine, vendors’ guild and many other sectors. The primary reason for the existence of self-regulation has always been a challenge against the government monopoly created through complex asymmetrical informational flow. The introduction of SRO for FinTech in India was not completely blindsided. In fact, the formulation of SRO could be traced back to the report submitted by “Inter-Regulatory Working Group on Fintech and Digital Banking” dated November 2017, wherein the committee suggested that a body comprising of representatives of various FinTech companies should be formed for addressing the regulatory lacuna that it was posing. Further, this suggestion was reiterated by many other working groups until the RBI announced its intention to form such an organization in February 2020, and a policy was introduced in August for public comment in the same year. The present framework is based on the comments received after these public consultations. The RBI’s policy framework for SRO stipulates certain touchstones for making of an SRO body and details out the governance framework and functions of SRO. The policy states the SRO should find behavioral and professional standards in the sector and enforce them based on mutual agreements. It says that SRO is answerable to the RBI and should act as the representative voice of its members in consultations with the RBI. The SRO is also asked with the duty of providing RBI with periodic reports. And further, the SRO is expected to play a constructive role in supplementing and complementing the existing regulatory frameworks. Now, regarding the governance of the SRO, the RBI has specified that one-third of the board of SRO should be independent members and all memberships should be at the satisfaction of RBI based on the relevant-fit-and proper criteria prescribed by the former. The framework provides that the SRO will be financially viable for fulfilling its objectives, and each member will be required to pay a uniform fee for membership. Moreover, SRO will remain as a not for profit organization following a transparent practice for governance. The promoters of the idea of self-regulation in finance based market space consider the formation of SRO to be a significant advantage over the direct government regulation as it exemplifies a market environment that is responsive, flexible, informed, and targeted. They emphasize its potential to create shared values among private players, thereby cultivating a sense of ownership and participation in rulemaking. But the reality is often bleaker than what it seems. To evaluate a policy of an SRO in fintech, one must first understand the purpose and objectives of fintech. Fintech companies stand as a blend of technology and finance to improve and automate economic services. They fill a void in market space that legacy institutions like banks have created in catering to the needs of the wider audience at the expense of customer experience. The primary objective of fintech is to either disrupt the traditional economic space or replace it with a new financial model. On this note, self-regulation for fintech fundamentally means self-serving. Because giving the halters of the future of fintech legal space to private players indicate a transition of power from public interest to private lead. Thereby, making what one would call an illusion of regulation where the profit-seeking enterprise wanders the field as a feral maverick. The next question that poses a threat to the working of the SRO is whether the independent directors of the SRO will truly be independent? If one was to follow section 149 (6) of the companies, Act in both the letter and spirit an obvious conclusion that will flow from it is that most of the independent directors of the companies are not really independent. The Indian experience of the working of companies over the past several years has shown that most of the independent directors are not really independent and have only been onlookers nominated by the board to witness the tussle between industrial heads. This is true in the case of SRO as well. Even though the policy in its present form stipulates a one by third independent membership, the members will not be truly independent in taking policy decisions as their minority interests could easily be thwarted by the two-third majority held by the private players. Another significant problem faced in the working of SRO is its lack of power in enforcing policy decisions. Even though SRO will be formed under the supervision of the RBI, the policy stipulates

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The Taxation of the Subscription Fees for the Online Database in India

Taxation Law /

[By Harshita Agrawal] The author is a student at the Ms. Ramaiah College of Law, Bangalore. Background In the current tech world, most companies share data online with their stakeholders to provide details of the company’s performance or in some cases to provide research reports in exchange for consideration. Post globalization, the supply of data is not bound to one territory but has widened to worldwide. These data or reports being copyrighted has created ambivalence between the tax authorities in India, for the royalty tax on the consideration received by the non-resident company in exchange for database used by customers in India. This created a lot of uncertainty on consideration received by these non-residents in the form of subscription fees and has prolonged since the advent of subscription fees started in India. This article will strive to give an outline of the current dispute between the tax authorities and non-residents relating to royalty tax on the sharing of an online database with the Indian customer. The article derives its contemporary relevance in light of the recent order of the Income Tax Appellate Tribunal (“ITAT”), Mumbai Bench in the case of IMS Ag, vDcit (Intl.Tax) Range 2(2)(1) (“IMS Ag case”). Factual Matrix of IMS Ag Case For better understanding, it is pertinent to delve into the facts of the case. IMS Ag (hereinafter referred to as “Assessee”) is a company incorporated and lodged in Switzerland. The Assessee’s primary business is providing subscription-based marketing research report of the pharmaceutical sector to its customers worldwide. The company delivers the data collected and processed by it through an online IMS knowledge link. For providing the review reports (“IMS reports”), the company enters into a service agreement with its customers to set out the details of the required modules to be accessed by the customers and the consideration received for these services. The dispute, in this case, was on the consideration received allowing the non-transferable and non-exclusive access to the IMS reports which was before the ITAT Mumbai. The learned Assessing Officer passed an order commanding the assessee to pay royalty tax on the above-disputed sum under Section 9(1)(vi) of the Income Tax Act, 1961 (“IT Act, 1961”) read with Article 12(3) of the Indo-Swiss Double Taxation Avoidance Agreement (“DTAA”). Aggrieved by the above order, the assessee approached the Mumbai ITAT to challenge the impugned order. The Mumbai ITAT while dealing with the aforesaid case has answered the two issues but our discussion will be limited to the issue of the requirement of payment of Royalty tax for the subscription fees paid by the Indian customer under Section 9(1)(vi) of the IT Act, 1961 read with Article 12(3) of India-Swiss DTAA. Judicial Advancements before IMG Ag Case Royalty tax on subscription fees has sprouted in the legal industry since the means of delivery of research reports shifted from physical mode to online mode. The tax authorities passed different views on this issue. At the outset, the ITAT Bangalore bench in the case of Wipro Limited v. ITO(2005), wherein the appellant had subscribed for the business data of Gartner Group.  The Tribunal while discussing the amplitude of both domestic laws and DTAA observed that the database was copyrighted and hence do not form royalty under Section 9(1)(vi) of the Act. In addition to this, the services were provided outside India and payment was also received outside India through banking channels, therefore, no tax would be levied in India.  This business income cannot be taxed in India as there is no business connection or Permanent Establishment (“PE”) of the non-resident, hence DTAA will also be not applicable. The Tribunal, in this case, have narrowed down the scope of royalty by connoting that web-based database is not included under Section 9(1)(vi) of the Act. On appeal, the Hon’ble High Court of Karnataka decried the dicta of ITAT Bangalore in the case of The Commissioner Of Income Tax(CIT) v. M/S Wipro Ltd (2011) wherein it reversed the order of ITAT. It was observed by the CIT that the subscription fees would be treated as royalty tax under Section 9(1)(vi) of the IT Act, 1961 read with Article 12 of India- Ireland Double Taxation Avoidance Agreement (DTAA).  According to the Hon’ble High Court, the payment of subscription grants the user a right over the data, thereby giving them royalty over the online database. . In the above case, the Hon’ble High court did not take into consideration Section 90(2) of the Act, which provides that in case of conflict between domestic laws and DTAA, whichever is more beneficial to the assessee will apply. In this case, DTAA will supersede the domestic laws as DTAA is more favorable to the respondent as it was not having PE in India. Arguments Advanced In IMS Ag Case The Revenue placed reliance on the ruling of the Karnataka High Court by claiming the taxability of subscription fees as royalty tax as per the domestic laws and India-Swiss DTAA. The Mumbai ITAT dissented from this view of the Revenue and placed reliance in the matter of DIT v. Dun and Bradstreet Information Services (DBIS) India Pvt Ltd[(2012)][i] (“DBIS Case”). In this case, the taxpayer imported business information reports (“BIRs”) from DBIS and made remittances without deducting tax at source under Section 195 of the IT Act, 1961.  The Advance Ruling (“AAR”) distinguished this case on the parameter that the payment made by the DBIS for the purchase of BIRs does not constitute a case of royalty as defined under Article 13(3) of the India-Spain DTAA. There was an illustration drawn in this case that right to use BIRs is similar to buying a copyrighted book in which the person has no right to change it. In the above facts, the AAR was of the view that such payment for the availing BIRs would not constitute royalty under Article 13(3) of the Indian-Spain Treaty. The same was upheld by the Mumbai High Court in DBIS Case. Order Passed by Mumbai ITAT in IMS Ag Case The ITAT of Mumbai per-curiam upheld

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AT-1 Capital: The Perpetual Problem

Capital Markets and Securities Law /

[By Devansh Parekh and Yuuvraj Vaidya] The authors are students at the Government Law College, Mumbai. Introduction In October 2020, the Securities and Exchange Board of India (“SEBI”) issued a circular[1] with respect to the issuance, listing, and trading of perpetual non-cumulative preference shares and perpetual debt instruments (“SEBI Circular”). The special focus herein is on certain instruments by the name of perpetual non-cumulative preference shares (“Perpetual Non-Cumulative Preference Shares”) and perpetual debt instruments (“Perpetual Debt Instruments”) which are issued as part of the additional tier of capital. This article centers on the provisions of the guidelines for implementation of Basel III which deals with instruments that form the layer of additional tier capital in a bank.   These instruments form a part of the special layer of capital that banks are permitted to issue which is commonly referred to as the regulatory capital. The SEBI Circular on the recommendation of the Corporate Bonds and Securitization Advisory Committee (CoBoSAC) proposed additional guidelines noting that the discretion under AT1 Instruments is reserved by the issuer and that retail individual investors may not be fully able to understand the true form of these instruments. This has become relevant after the recent Yes Bank controversy and the ensuing case of Piyush Bokaria vs Reserve Bank of India [1] which have been analyzed in this article. Implementation of Basel III Capital Regulations In India Due to globalization, there has been a great integration of international banks and interdependence of financial markets that prompted the birth of the Basel Accord, which brought in standardized measurements. It is imperative to understand the Basel Accord and how it functions. The Basel Accord was set up by the Basel Committee on Bank Supervision that provided recommendations on banking regulations. It has three series of recommendations – Basel I, II & III. The Basel III capital regulations were implemented in India from April 1, 2013, in a phased manner. The Reserve Bank of India published its Master Circular dated July 1, 2015, consolidating guidelines pertaining to the Basel III norms along with guidelines for implementation of Basel III. (“Basel III Framework”) The accords were drafted to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses.[2] Tier 1 capital deals with the primary funding of banks that are disclosed on financial statements, such as common shares, free reserves, statutory reserves, etc. Tier 2 capital includes general provisions and loss reserves, debt instruments, share premium, etc. Not until a long time ago, there existed a third layer i.e., Tier Capital 3 that had a great variety of debt but was of inferior quality than the above tiers and has been abrogated. These instruments are distinguishable from ordinary securities because of certain peculiar rights the issuer has upon them which could be considered onerous for the holder, viz., loss absorption capacity which has been discussed in further detail below. Loss Absorption of Non-Equity Regulatory Capital Instruments  As per the Basel III Framework, non-equity instruments, which form the additional tier of capital for banks, shall have the inherent characteristic of absorbing losses of the bank even as the entity remains a going concern. As per the Basel III Framework, the terms of issuance of Perpetual Debt Instruments and Perpetual Non-Cumulative Preference Shares in Additional Tier 1 (collectively referred to as “AT1 Instruments”) shall include provisions for either (1) conversion to common shares at the occurrence of a pre-specified trigger point or (2) a write-down mechanism allocating the losses at the occurrence of a pre-specified trigger point. The Based III Framework stipulates that upon the capital conservation buffer [3] falling below a certain threshold it will trigger a write-down/conversion of the AT1 Instruments, described hereinbefore, to ensure the bank is operating above a certain CET 1 ratio.[4] The conversion/ write-down is intended to replenish the equity which is depleted due to losses. The risk under these AT1 instruments is evidently amplified by the fact that if the bank goes into liquidation after the AT1 instruments have been written down permanently, there shall be no claim remaining upon the liquidator for recovery of the principal under these instruments. The write-down will essentially mean that the AT1 instruments have been erased from the balance sheet and existence and all rights and obligations have ceased. The repercussions of write off or conversions arise in a situation of non-viability of the bank which means “A bank which, owing to its financial and other difficulties, may no longer remain a going concern on its own in the opinion of the Reserve Bank unless appropriate measures are taken to revive its operations and thus, enable it to continue as a going concern.”[5] Therefore upon the occurrence of ‘Point of Non-Viability Trigger Event’ which could be (1) the RBI directing the write off/conversion of the AT1 instruments or (2) decision to infuse public sector capital without which the bank would not be able to sustain its going concern status, as determined by the relevant authority, the appropriate action of write-down or conversion shall be initiated. SEBI Circular  The pertinent changes proposed by the SEBI Circular include: (1) All issuance is to be done on the electronic book platform. (2) Only Qualified Institutional Buyers (“QIB”) shall be allowed to participate in the issue. (3)The minimum allotment size for an investor shall be INR 1 Crore. (4) An important disclosure that would be required as per the SEBI Circular is the disclosure of risks, particularly the discretion in terms of writing down the principal/interest, to skip interest payments, to make an early recall, etc. without commensurate right for investors to legal recourse, even if such actions of the issuer might result in a potential loss to investors.[6] QIB such as scheduled commercial banks, mutual funds, FPIs, AIFs, etc are perceived to bring in sophisticated capital and have the financial wherewithal and understanding to commit investments in complex and/or sizeable transaction, as they undertake comprehensive legal and financial due diligence on their investee targets. YES Bank Case

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Need For Multilateral Framework In Investment Arbitration For Dispute Resolution

Arbitration Law /

[By Sourav Verma and Sunil Singh] The authors are students at the Hidayatullah National Law University, Raipur. Introduction In the last two decades of the 20th century, due to globalization as well as liberalization, there has been an increase in the free-flow of foreign investments, especially in developing countries. Due to this, great changes have taken place in the foreign investment regime, mainly in the form of Bilateral and Multilateral Investment Treaties. These treaties have had a significant impact on aspects such as national sovereignty, federalism, and public policy decisions that relate to the health and environment of the host countries. With the tremendous rise in the number of BITs and MITs, there is also an increase in the amount of investment treaty arbitration. However, concerns have arisen with respect to inconsistent arbitral awards, lack of transparency, parallel arbitration proceedings, impartiality and diversity in the appointment of arbitrators, and delay in the award making process[i]. In the past two decades, there have been some inconsistent awards delivered by tribunals in Investment treaty arbitration, which in turn have faced criticism from academicians, sovereigns, investors. However, while absolute consistency in any legal system is not possible, at least a minimum level of consistency is necessary in any legal system to attain certainty. This article specifically focuses on the SGS arbitrations[ii] and Lauder arbitrations involving similar facts and circumstances in which tribunals reached contradictory conclusions, which attracted a great deal of public attention. SGS Arbitrations The SGS arbitrations involved two arbitration proceedings, (i) between SGS Société Générale de Surveillance S.A. v. Islamic Republic of Pakistan (‘SGS v. Pakistan’)  and (ii) SGS Société Générale de Surveillance S.A. v. Republic of the Philippines (‘SGS v. Philippines’), in which tribunals came to different conclusions regarding the interpretation of the umbrella clause which is also known as “observance of undertaking” involving almost similar facts. SGS v. Pakistan was the first investment treaty arbitration in which the tribunal considered the meaning of an umbrella clause. SGS, by relying on Article 11 of the Switzerland-Pakistan BIT, claimed that it was the duty of “every state to observe all the obligations that it should enter in relation to foreign investments”.[iii] The tribunal in that case held that the claimant failed to provide evidence “that the parties to the BIT intended that umbrella clause transmute a contractual breach to the level of a treaty breach. The tribunal on the basis of lack of evidence rejected the broad interpretation and denied the claimant’s claim. Only after the gap of five months, SGS sued the Republic of Philippines and the factual matrix of the SGS v. Philippines was almost similar to that of SGS v. Pakistan. Despite this similarity, the tribunal reached a different result which is the opposite of the previous decision through a different analysis. Article X(2) of the Switzerland-Philippines BIT  provided that every Sovereign “shall observe all the obligations undertaken with regard to investments in its territory by the investors of other Sovereigns. By relying on the article X (2), the tribunal observed that it was the “duty of every Sovereign to observe all the obligations it has accepted or will, in future, accept with investments under the purview of the BITs”. The tribunal concluded that due to the umbrella clause, “Philippines breached the binding and contractual commitments that it has presumed under the BIT, with regard to the specific foreign investments. The Philippines award is diametrically opposite to the Pakistan award. While the decision of the tribunal in SGS V. Pakistan is based on a narrow interpretation of the treaty, the tribunal in SGS v. Philippines concluded its decision on rather a broad interpretation. Therefore, it is undeniable that one of the decision is based on an incorrect interpretation of the treaty, that leads to confusing all the stakeholders regarding the correct implementation of the umbrella clause. The Lauder Arbitrations Lauder v. Czech Republic and CME v Czech Republic are two arbitral proceedings that were initiated against the Czech Republic for the violations of Czech Republic-USA BIT  and Netherlands-Czech Republic BIT respectively. Both the tribunals reached very conflicting, and therefore opposite conclusions in relation to each other, even though the underlying facts were the same. The Lauder tribunal held that the Czech Republic engaged in discriminatory and arbitrary treatment of investments.  Further, the tribunal noted that there was neither expropriation nor violation of either the duty to provide fair and equitable treatment (FET) or the obligation to provide full security and protection. Finally, the tribunal concluded that the Czech Republic had not breached its obligations under the investment treaty and therefore owed no damages to Lauder. Only after a gap of ten days, the CME tribunal reached a conclusion that was the exact opposite of the Lauder tribunal. The CME Tribunal held that the Czech Republic had not fulfilled its obligations related to fair and equitable treatment, full security and protection of investments, obligation to treat investments in conformity with principles of international law, and obligations not to impair investments by unreasonable or discriminatory measures. The tribunal awarded CME damages worth US $269,814,000. Later, Czech Republic moved Sweden’s Svea Court of Appeal to vacate the award of the CME tribunal. The Svea Court of Appeal refused to set aside the award opining that it had very narrow review power and only in exceptional circumstances could an award be set aside[iv]. The Svea Court of Appeal accepted the existence of parallel proceedings by the Lauder tribunal in London but refused to interfere on the ground that it had no jurisdiction and also refused to apply res judicata or lis pendens because the two awards involved different parties under different BITs entered between different Sovereigns. The contradictory decisions rendered in the Lauder cases result in undermining the legitimacy of investment arbitration, particularly where disputes related to public policy, environmental and human rights, and public health are at stake. Analysis Various academic literature, practitioners, etc. of this discipline have already discussed numerous approaches to resolve this issue of inconsistency. A common

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