Shares inCairn Energy(LSE: CNE) have slumped by a fifth today after the companyreceived a draft assessment order from the Indian Income Tax Department.
The draft order wasaddressed to Cairns subsidiary, Cairn UK Holdings Limited and claims that the company owes $1.6bn roughly 1.1bn in unpaid taxes, plusany applicable interest and penalties.
According to Cairn Energy, theIndian Income Tax Department is seeking this paymentin respect of fiscal year 2006/7. The bill is related to the capital gains Cairn madewhile transferring all of its Indian assets to a new company, Cairn India.
Unfortunately,the tax assessment and resulting tax bill stems from amendments introduced in the 2012 Finance Act. So, this unpaid tax bill is clearly a surprise for Cairn.
According to todays press release on the matter, Cairns management has continuously sought the advice of its tax advisersthroughout its history of operating in India. According to the advice it has received, the company has been fully compliant with the tax legislation in force in each year, and has paid all applicable taxes.
And on this basis, Cairn has filed aNotice of Dispute under the UK-India Investment Treaty in an attempt toclear the tax bill.
Resolution will take time
Theres no doubt that this tax bill lumped on Cairn through retroactive legislation, is a huge blow for the company and a set-back for UK-India relations.
Cairns market value is only 816m at time of writing, so if the company is made to pay the tax bill it will struggle to find the cash. Cairns preliminary results, showed net cash of $869m at the end of December 2014. The company also had an undrawn seven year credit facility of $575m and a $703mresidual shareholding in Cairn India Limited, although Cairn has been blocked from selling this holding.
Still, under the terms of the UK-India Investment Treaty, now Cairn has filed a Notice of Dispute, the Government of India and Cairn are now required to enter a period of negotiations to seek a resolution to the issue.
If a satisfactory resolution is not reached during that period, an international arbitration panel will be constituted to adjudicate on the matter.
So, it looks as if the company will receive a fair trial at the hands of its international peers. As a result, according to the companys management, Cairn does not intend tomake any accounting provision in respect of the draft tax assessment. In other words, Cairns management, accountants and legal counsels do not believe that the company will have to pay this potentially crippling tax bill.
That being said, it is notoriously difficult to operate within India, and a resolution to this dispute could take months, if not years. The cost of a long drawn out tax battle could hold back Cairns growth.
Unfortunately, City analysts arent expecting big things from Cairn over the next two years. Current figures suggest that the company will report a loss of 70m this year, with a further loss of 83m expected for 2016.
So, with the City expecting Cairns losses to grow over the next few years and a billion dollar tax battle to fight, Cairns future is uncertain. And while the company does have plenty of cash on hand, its not a stock for widows and orphans.
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