An international arbitration tribunal in The Hague ruled that India's imposition of a tax liability on Vodafone, as well as interest and penalties, were in a breach of an investment treaty agreement between India and the Netherlands, two sources with direct knowledge of the matter said.
India had claimed a total of 279 billion rupees ($3.79 billion) including about $2 billion in tax, as well as interest and penalties, one of the sources said.
The tribunal, in its ruling, said the government's demand is in breach of "fair and equitable treatment" and it must cease seeking the dues from Vodafone. It also directed India to pay 4.3 million pounds ($5.47 million) to the company as compensation for its legal costs, one of the sources added.
Vodafone said in a statement the amount of the award was confidential. Shares in the company's India unit, Vodafone Idea, ended 13% higher on Friday.
"The tribunal held that any attempt by India to enforce the tax demand would be a violation of India's international law obligations," Vodafone said in its statement.
India's finance ministry said it will carefully study the award, together with its lawyers. "After such consultations, the government will consider all options and take a decision on further course of action including legal remedies," the ministry said in a statement.
"Vodafone has finally got justice first from the Indian Supreme Court and now from an international arbitral tribunal," said Anuradha Dutt, senior partner at DMD Advocates, an Indian law firm representing the company.
The ruling brings an end to one of the most controversial disputes in India under international treaty agreements that it enters into with countries to protect foreign investments.
India is entangled in more than a dozen such cases against companies, including Cairn Energy, over retrospective tax claims and cancellation of contracts. The exchequer could end up paying billions of dollars in damages if it loses.
To reduce future arbitration claims, India has ended such agreements with over 50 countries and is working on a new law to protect foreign investors by offering relief from possible policy changes even as it upholds the right to tax them, Reuters reported.
Vodafone's tax dispute stems from its $11 billion deal to buy the Indian mobile assets from Hutchison Whampoa in 2007. The government said Vodafone was liable to pay taxes on the acquisition, which the company contested.
In 2012, India's top court ruled in favour of the telecom provider but the government changed the rules to enable it to tax deals that had already been concluded.
In 2014, Vodafone initiated arbitration proceedings against India.
By Aditi Shah