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Cairn Energy PLC Slumps 20% On Tax Revelations

Shares in Cairn Energy (LSE: CNE) have slumped by a fifth today after the company received a draft assessment order from the Indian Income Tax Department.

The draft order was addressed to Cairn’s subsidiary, Cairn UK Holdings Limited and claims that the company owes $1.6bn — roughly £1.1bn — in unpaid taxes, plus any applicable interest and penalties.

According to Cairn Energy, the Indian Income Tax Department is seeking this payment in respect of fiscal year 2006/7. The bill is related to the capital gains Cairn made while 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 today’s press release on the matter, Cairn’s management has continuously sought the advice of its tax advisers throughout 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 a Notice of Dispute under the UK-India Investment Treaty in an attempt to clear the tax bill.

Resolution will take time 

There’s 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. 

Cairn’s 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. Cairn’s 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 $703m residual 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 company’s management, Cairn does not intend to make any accounting provision in respect of the draft tax assessment. In other words, Cairn’s 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 Cairn’s growth. 

Losses growing

Unfortunately, City analysts aren’t 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 Cairn’s losses to grow over the next few years and a billion dollar tax battle to fight, Cairn’s future is uncertain. And while the company does have plenty of cash on hand, it’s not a stock for widows and orphans.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.