[Kartikey Mahajan is a Partner, Jatan Artur Rodrigues a Senior Associate, and Keshav Somani an Associate, all part of the Dispute Resolution practice group of Khaitan and Co.
The authors would like to thank Rohan Sanjith (Paralegal at Khaitan & Co and a final-year student at Indian International University of Legal Education and Research) for his contribution]
On 25 July 2024, a nine-judge bench of the Indian Supreme Court in Mineral Area Development Authority v. Steel Authority of India overruled a long-standing precedent that classified mining royalty payments under the [Indian] Mines and Minerals (Development and Regulation) Act, 1957 (“MMDR Act”) as a “tax”. In classifying royalty as tax, Indian state governments were deprived of imposing their own taxes on mineral rights and mineral land. However, in Mineral Area Development, the Supreme Court concluded that royalty is not a tax but a contractual payment, and Indian state governments are competent to tax mineral rights and mineral land. Interestingly, the Supreme Court applied Mineral Area Development retrospectively from 1 April 2005, thereby allowing Indian state governments to levy tax demands on mining companies on transactions concluded on or after 1 April 2005 (see order of 14 August 2024).
Industry experts have cautioned that applying Mineral Area Development retrospectively could cause mining companies to be subject to total tax liabilities of USD 17.86 billion. In this post, the authors address the potential implications of such retrospective application on India’s obligations under its bilateral investment treaties (“BITs”), particularly the obligation to accord fair and equitable treatment (“FET”) to investors. Irrespective of India’s termination of BITs between 2016 and 2021, investments prior to such termination remain protected under the sunset/ survival clauses in the respective BITs (typically for 10 to 15 years). While the Model India BIT 2015 excludes the broader FET standard, the erstwhile Model India BIT 2003 contained a broad standard requiring investments of foreign investors to be accorded fair and equitable treatment at all times. This broad formulation was retained in around 32 BITs and has also been subject to interpretation by investor state dispute settlement (“ISDS”) tribunals, as discussed below.
Background and Summary of Mineral Area Development
India follows a federal structure with powers to legislate on different subject matters divided between the Union (or Central) government and state governments. These allocations of subject matter are provided for in List 1 and List 2 of the Seventh Schedule of the Constitution of India. Entry 54 of List 1 entitles the Union government to enact laws regulating mines and mineral development. Entries 49 and 50 of List II entitle state governments to impose taxes on: (i) land and buildings; and (ii) mineral rights subject to any limitation contained in a Union law relating to mineral development, respectively. In exercise of the power under Entry 54 of List 1, the Indian government enacted the MMDR Act. Section 9 of the MMDR Act requires a mining leaseholder to pay a royalty to the respective state government for extracting minerals from leased areas. The second schedule to the MMDR Act specifies the royalty rates for different minerals, which cannot be enhanced or reduced more than once during a period of three years.
In 1989, seven-judge bench of the Supreme Court in India Cement Limited v. State of Tamil Nadu concluded that since royalty payment under section 9 is itself a “tax”, the Union law would constitute a limitation on state governments’ power to impose further tax on royalty or mineral rights. In 2004, a five-judge bench of the Supreme Court in State of West Bengal v. Kesoram Industries held that: (i) royalty is not a tax; (ii) the phrase “royalty is a tax” in India Cement was an inadvertent error and the Supreme Court intended to state that “cess on royalty is a tax” (pages 636 and 642). Nevertheless, India Cement, a decision of a higher bench strength, continued to hold the field. In 2011, a three-judge bench of the Supreme Court noted the divergence between India Cement and Kesoram Industries and referred the controversy to a nine-judge bench of the Supreme Court.
Accordingly, in Mineral Area Development, the Supreme Court (by way of an 8:1 majority) held as follows:
- Royalty payment under section 9 does not fulfil the essential characteristics of a tax and is a contractual payment pursuant to the mining lease (paragraph 125);
- Indian state governments can impose taxes on the exercise of mineral rights pursuant to Entry 50 of List II, and section 9 or the limitation on enhancement of royalty rates does not constitute a limitation on state governments’ power (paragraphs 187, 224 and 230);
- Indian state governments can also impose taxes on mineral bearing lands using royalty as a measure of tax. Such power would remain unaffected by any law relating to mineral development as this limitation is only prescribed for Entry 50 of List II (paragraphs 278, 282 and 331).
In a sole dissenting opinion, Justice B.V. Nagarathna held that: (i) the mandatory nature of royalty under section 9 of the MMDR Act would qualify it as a tax; (ii) such stipulation of royalty payment by the Union constitutes a limitation on state governments from collecting taxes on mineral rights; and (iii) state governments cannot tax mineral land as they are already taxed through royalty under section 9. Notably, Justice Nagarathna also cautioned against the adverse commercial impact of the Supreme Court’s decision since, over and above the mandatory royalty payments, mining companies would now have to pay taxes on mineral rights under state legislations – a detail to which the authors return to below.
India’s Obligations under BITs
In this part, the authors analyse whether allowing Indian states to levy tax demands retrospectively pursuant to their state legislations, despite some of them being declared unconstitutional based on India Cement, violates the FET standard.
Contours of the FET standard
Investment tribunals have recognised the principle to maintain a predictable and stable legal framework for investments as an essential feature of the FET standard under BITs (see Lemire v. Ukraine, paragraph 284; Murphy Exploration v. Ecuador, paragraph 206; Cairn v. India; paragraph 1757). However, certain tribunals have qualified this right to those circumstances where the change in regulations is contrary to some specific commitment made by the State (see Ioan Micula v. Romania, paragraph 529; CMS Gas Transmission v. Argentina, paragraph 277). Nevertheless, in the context of retroactive legislations, after analysing previous jurisprudence and scholarly opinion, the Cairn tribunal concluded that, even without specific commitments, an investor is entitled to expect that regulations will apply prospectively (paragraphs 1778-1784). Thus, the Cairn tribunal considered a retroactive legislation to violate the principle of legal certainty for depriving investors of predicting the legal consequences of their conduct based on prevailing laws (paragraph 1757). A retroactive legislation could only be justified when introduced for a specific public purpose, which: (i) extends beyond the general objective of raising funds for public welfare; and (ii) manifestly outweighs the prejudice suffered by individuals from such retroactive application (paragraph 1760).
Retrospective application of the Mineral Area judgment violates the FET standard
The Supreme Court’s order of 14 August 2024 does not disclose any specific public purpose for retrospectively applying Mineral Area Development. Rather, the Supreme Court merely considers that since a prospective application would render state legislations enacted under Entries 49 and 50 of List II invalid based on a position of law now overruled, this will not be a “constitutionally just outcome” (paragraph 19).
After India Cement, for almost 35 years, mining companies operated under the framework where state governments could not impose taxes on royalty or use royalty as a measure to tax mineral rights. Mining companies structured their financial affairs and commercial transactions based on the law declared in India Cement. A retrospective application of Mineral Area Development would unsettle several such commercial bargains. Moreover, as this tax would be levied retrospectively, mining companies would struggle to pass the liability to end users. Several companies had argued that retrospective tax demands could exceed their net worth, leading to potential bankruptcies.
Further, after India Cement, the Union Government increased royalty rates to compensate state governments for losing the revenue from taxes on royalty and mineral rights (see paragraph 20). For instance, the Indian Government significantly increased royalty rates for different varieties of coal by 200-400 percent. Therefore, after having benefitted from increased royalty rates, allowing state governments now to levy tax demands retrospectively does not achieve a specific public purpose that manifestly outweighs the prejudice to mining operators.
Judicial acts and violation of the FET standard
In this case, the action potentially impairing the rights of foreign investors is a judicial act rather than an executive or legislative act. However, it is largely accepted under general international law that judicial acts can equally trigger a State’s international legal responsibility. Indeed, Article 4 of the Articles on Responsibility of States for Internationally Wrongful Acts and the International Law Commission’s commentary to Article 4 make no distinction between actions of legislative, executive or judicial organs, for which a State may be internationally responsible. In its Immunity from Legal Process of a Special Rapporteur advisory opinion, the International Court of Justice considered this rule to reflect customary character and held that the conduct of an organ independent of the executive power would also constitute an act of the State (paragraphs 62 and 63). Specifically, in the context of international investment law, investment tribunals have held that judicial decisions, in themselves, can violate the FET standard under BITs even without constituting a denial of justice (see Infinito Gold v. Republic of Costa Rica, paragraphs 359 and 360; OAO Taftnet v. Ukraine, paragraph 407).
Conclusion
As an incidence of sovereignty, a state is entitled to change its legal framework unless it has made specific assurances to the contrary. However, when a state’s legislative organ enacts a retrospective legislation without any specific public purpose, it violates the FET standard. Similarly, a domestic court applying its decision retrospectively could also violate the FET standard since international law makes no distinction between the different organs of a state. In this scenario, the issue before an investment tribunal will not be to determine the correctness of the Supreme Court’s decision, resulting in the change of legal framework, but only if that could be done retrospectively. Thus, while Mineral Area Development may constitutionally be correct and its retrospective application may be a constitutionally just outcome, it could potentially trigger India’s responsibility under its BITs where such retrospective application will be tested against the FET standard under international law.
– Kartikey Mahajan, Jatan Artur Rodrigues & Keshav Somani
