C h a l l e n g e U s

Transcription

1 C h a l l e n g e U s

2 Firm and Limited Liability Partnership Association of Person May 27, 2016 Chennai Overview of Tax aspects Pranith Golecha and Varatharaj Kumar

3 Silent Features Partnership Firm Persons who have entered into partnership with one another are called partners individually and a firm collectively A partnership is a common vehicle in India for carrying on business activities on a small or medium scale. Under partnership law, a partnership firm is not a legal entity, but it only consists of individual partners for the time being to generate income or get profit. However, for income-tax and sales tax purposes, it has limited identity and has been considered as the legal entity.

4 Silent Features - LLP Body corporate and separate legal entity Perpetual succession Partners/ LLP shall be governed by LLP Agreement LLP is liable to the extent of its assets and Partner s are liable to the extent of agreed capital contribution in the LLP Agreement

5 Framework of Taxation of Firms and LLP Firm - Not been defined under the Act Section 2(23) of the Act - Firm, partner and partnership have the meanings, respectively assigned to them in the Indian Partnership Act, A firm is taxed as a separate legal entity for income tax purpose From the Assessment Year onwards these provisions are also applicable to Limited Liability Partnership

6 Framework of Taxation of Firms and LLP Tax rate for firm - 30 percent plus surcharge and cess Any salary, bonus, commission or remuneration (by whatever name called) paid/payable to partners is allowed as a deduction to the firm Subject to conditions and restrictions Interest on partner s capital is allowed as deduction Subject to conditions and restrictions The share of the partner in the income of the firm is not included in computing his total income

7 Content Residential Status Interest deductibility Remuneration and book profit Contribution of assets into the Firm / LLP Retirement of Partner Taxation in the hands of partners other issues Carry forward of loss Conversion Business models

8 Residential status Residential status determined qua firm u/s 6(2) read with sec 6(5) A firm is said to be resident in India in any previous year in every case except where during that year the control and management of its affairs is situated wholly outside India - Mere activity in one place does not create residence - Control and management refers to controlling and directing power/ head and brain - Affairs are those which have some bearing to income - De facto control, not de jure control relevant Supreme Court ruling in the case of Narottam (23 ITR 454) and Naik (14 ITR 334)

9 Residential Status Foreign Company Control and Management All directions are given from outside India Outside India India All the commercial and Management decision are taken outside India LLP Applicable tax rate for business income?

10 India holding company as LLP? Foreign Company Control and Management is fully outside India Outside India Capital gains tax rate 10% India LLP Investment holding Company subject to FEMA conditions Indian Company 1 Indian Company 2 LLP

11 Conditions under section 184 of the Act A firm must be evidenced by an instrument; - The deed must be in writing; - Partnership should not be by conduct or oral partnership; Profit sharing ratio of partners must be specified in the instrument A certified copy of the instrument should be submitted There should not be any failure as mentioned in section 144 of the Act

12 Interest to Partners Section 40(b) provides the following limitation on deductibility of interest, subject to following conditions: - Payment of interest to be authorized by and to be in accordance with partnership deed [LLP Agreement] - Interest to relate to a period falling after the date of partnership deed - Interest should not exceed 12% per annum - Interest paid to an individual partner acting in a representative capacity, (on loan/ capital provided) otherwise than in representative capacity - Interest paid to an individual partner on behalf of, or for the benefit of any other person

13 Interest to Partners Whether partner can claim interest on loan borrowed against the interest on capital invested in Firm Held Yes Delhi High Court in the case of Karan Raghav Export (2010 (11) TMI 111) Partner s capital is used for purpose other than business Interest on capital allowed Held No Munjal Sales Corporation (2008 (2) TMI 19)

14 Interest to Non-resident Partners Outside India India Foreign Company Interest on Capital Act: Business income Treaty: LLP Under the treaty - Interest income (Sunil V Motiani (ITA No. 276/Mum/2012) Interest income Dividend income Business income Other income

15 Remuneration of Partners Remuneration should be paid only to a working partner; - Should the working partner be only an individual? - The partner must be actively engaged in the business of the LLP Activities performed Activities not performed Is he a working partner? Framing business policies Business decision making Effecting Business transactions Attends general administration No participation in implementation and other routine jobs No participation in implementation and other routine jobs No participation in administrative and other routine jobs No participation in decision-making Performs routine jobs No participation in decision-making Yes Yes Yes Yes Yes

16 Conditions under section 40(b) of the Act Activities performed Activities not performed Is he a working partner? Partner on account of relationship and/or capital Partner on account of relationship and/or capital Temporarily carries on some work in the absence of a regular partner No knowledge of the business performed by the LLP No participation in the working of the business Otherwise no participation No No No Hence, the functions of a working partner would include Planning; Organizing; Directing; Staffing; and Controlling the core of business namely, production, marketing, finance, etc

17 Conditions under section 40(b) of the Act Remuneration must be authorised by the partnership deed; - What does Circular No. 739 say? Remuneration should not pertain to period prior to partnership deed; and Remuneration should not exceed permissible limit Book Profit If book profit is negative In case book profit is positive Amount deductible in respect of remuneration to partners under section 40(b) of the Act Rs 1.5 lakhs On first 3 lakhs of book profit Rs 1.5 lakhs or 90 percent of book profit whichever is more On balance 60 percent of book profit

18 How to Compute Book Profit for the purpose of section 40(b) of the Act Steps involved in Computation of Book Profit Steps to Compute Book Profit Step 1 Find out the net profit of the LLP as per Profit and Loss Account Step 2 Make adjustment as provided in sections 28 to 44DB of the Act Step 3 Add remuneration to partners if debited to the Profit and Loss Account

19 Implications of manner of computation of Book Profit Income of other heads of income such Income from House Property, Capital Gains and Income from other sources would not form part of total income. Treatment of Brought forward Business Loss To be ignored Treatment of other permissible deductions from section 80C to section 80U of the Act To be ignored Issues Will interest income earned on Fixed Deposits held by a LLP for business purpose form part business income or not? Whether remuneration paid and allowable under section 40(b) of the Act can be disallowed under section 40A(2) of the Act

20 Transfer of Capital Asset into Firm by Partner Partners Firm / LLP Contribution of Intangibles as capital Act: Amount recorded in the books of the e firm - Deemed to be the full value of the consideration LLP Act: Sec 32 of LLP Act r/w Rule 23 of LLP Rules

21 Transfer of Capital Asset by Firm to Partner Per section 45(4): The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer Conflicting views on whether s 45(4) applies on retirement of a partner In any event, it has been held in HC judgments that sec 45(4) does not apply to a case of retirement/ dissolution where cash is paid out to a partner on retirement as per the terms of the partnership deed o CIT vs Dynamic Enterprises 40 taxman.com 318 (Kar) In such cases, SC decisions that the receipt should not be taxable in the hands of the partners since it represents realization of a right rather than transfer o o Malabar Fisheries Co. vs CIT 120 ITR 49 (SC) CIT vs Mahanbhai Pamabhai 165 ITR 166 (SC) Challenge us 21

22 Transfer of Capital Asset by Firm to Partner Retirement Provisions in Partnership Act and LLP Act Section 37 of the Partnership Act: Where any member of the firm has died or otherwise ceased to be a partner, and the surviving or continuing partners carry on the business of the firm with the property of the firm without any final settlement of accounts as between them Section 24(5) of the LLP Act: Retiring shall be entitled to receive from the limited liability partnership: - an amount equal to the capital contribution of the former partner actually made to the limited liability partnership; and - his right to share in the accumulated profits of the limited liability partnership after the deduction of accumulated losses of the limited liability partnership, determined as at the date the former partner ceased to be a partner Challenge us 22

23 Carry forward and set off losses Change in constitution of LLP Section 78 of the Act Section 78 of the Act provides that where there is a change in the constitution of the LLP on account of death/retirement, the firm shall not be entitled to carry forward of so much of the loss as is attributable to such partner Step 1 Manner of computation Ascertain the share of the outgoing partner in the profit/loss of the LLP in the year of change in the constitution of LLP Step 2 Step 3 Compute the share of loss of outgoing partner in the brought forward loss The difference between step 1 and step 2 (in case of profit in the year of change of constitution) or the aggregate of step 1 and step 2 (in case of loss in the year of change of constitution) cannot be allowed to be set off and carry forward

24 Carry forward and set off losses Change in constitution of LLP Section 78 of the Act However, it must be noted that this provision only covers a situation when a partner goes out of the firm. It does not, however cover a case of change in profit sharing ratio or the case of admission in partnership. LLP has perpetual succession, so whether retirement or death will be treated as change in constitution?

25 Dissolution of Firm and Succession Profit or loss arising from transfer of a capital asset by way of distribution of capital assets on dissolution of Firm is chargeable to tax as income of the Firm in the tax year in which the said distribution takes place The fair market value of the asset on the date of such distribution shall be deemed to be the full value of the consideration received or accrued as a result of the distribution The partners of the firm at the time of dissolution shall be jointly and severally liable for the amount of any tax, penalty or any other sums payable as determined under the scrutiny proceedings Separate assessment to be made on predecessor firm and successor firm in case of succession which is not covered under section 187 (ie on change in constitution of the firm)

26 Taxation of Partners- Recent update CBDT clarifies that the partner s share of profit in the firm s total income is exempt in the hands of partner even if the income is exempt in the hands of the firm The total income of the firm for the purpose of interpretation of Section 10(2A) of the Act, includes income which is exempt or deductible under various provisions of the Act Accordingly, the income of the firm is to be taxed only in the hands of the firm and under no circumstances it can be taxed in the hands of its partners Accordingly, the entire profit credited to the partners accounts in the firm would be exempt from tax in the hands of such partners, even if the income chargeable to tax becomes nil in the hands of the firm on account of any exemption.

27 Taxation of Partners Transfer of LLP interest Outside India F Co. 1 LLP India F Co. 2 Transfers interest Treaty Taxable only in Residence state: 1. Mauritius 2. Singapore 3. Philippines 4. South Africa 5. Denmark 6. France 7. Germany 8. Japan 9. Netherlands Under the treaty, will the LLP be treated as Company?

28 Conversion COMPANY To LLP LLP To COMPANY FIRM To COMPANY FIRM To LLP

29 Business Models Company or LLP AOP or LLP Investment holding model F Co. F Co Promoter holding company/ Investment LLP Outside India India I Co. I Co. 1 I Co. 2 Company Advantages: No MAT No DDT LLP Project AOP LLP Lower tax cost with mitigation of Association of Persons exposure Recurring savings (DDT and MAT related) One time tax savings (MAT related at the time of divestment) NBFC neutralization

30 Business Models Projects Cash Pooling Companies I Co. 1 I Co.2 Project Co.1 Project Co.2 Project Co.3 Rs 100 Rs 1 Cr. LLP1 LLP2 LLP3 Partnership More tax efficient repatriation without MAT outflow Risk in each of the project can be alignated Free circulation of cash No deemed dividend

31 Taxation of LLP In a Nutshell LLP are taxed at effective rate of 30% (plus surcharge and education cess) AMT 18.5% on Adjusted Total Income*) introduced on LLP by Finance Act, 2013 w.e.f 1 April 2013 No dividend distribution tax on its profit distributions Loss attributable to a retiring partner cannot be carried forward Share of profits of the LLP received by the partners is exempt in the hands of the respective partners Interest on capital paid to partners is allowed as a deduction to the LLP

32 Company to LLP All assets and liabilities should be transferred All the shareholders becomes partners in LLP Consideration should be in the form of capital contribution and profit sharing Turnover and assets should not have exceeded INR 60 lakhs and INR 5 crore respectively in the last 3 years Shareholders should collectively hold atleast 51 percent of the profit sharing ratio for 5 years No repatriation out of accumulated profit for 3 years

33 Tax neutrality violation of prescribed condition Two level test has to be satisfied for conversion to be tax neutral for Company as well to shareholder Level 1 Satisfaction of Transfer definition There should be a transfer under the charging section for capital gains i.e., section 45 of the Income-tax Act, 1961 ( the Act ) Yes Level 2 Satisfaction of prescribed exemption condition Satisfaction of prescribed conditions to exclude from the definition of transfer under section 47(xiiib) of the Act No Yes Conversion is Tax Neutral Conversion by operation of law is not a Transfer - Madurai Mills Co Ltd (89 ITR 45) Conversion of firm to company will not be treated as Transfer The Bombay High Court in the case of CIT Vs Texspin Engg & Mfg Works (263 ITR 345) The Gujarat High Court in the case of R L Kalathia (66 taxmann 249)

34 TAXATION OF AOP May 27, 2016 Chennai Pranith Golecha

35 AOP TAXATION Concept of AOP Definition of Person Members of AOP Judicial Precedents Residential status of AOP Taxability of members and AOP (with case studies) Examples Key takeaways

36 Concept of AOP CONCEPT OF AOP AOP is a separate taxable entity under the Act distinct from its constituting members Section 2(31) of the Act The term AOP has not been defined in the Act no single test or guiding principle. Fact driven There is no formula of universal application as to what facts, how many of them and of what nature, are necessary to come to a conclusion that there is an AOP Supreme Court Judicial precedents on the subject Some of the parameters to ascertain the existence of an AOP have been mentioned below: Two or more persons associate themselves with the object of deriving income, profits or gains Voluntary combination Common purpose Joint management Mutual rights and obligations Joint execution of work Joint and several liabilities of members Sharing of profits in agreed proportion between the members 36

37 QUOTE, UNQUOTE HOW THE LAW EVOLVED combinations of individuals combination of persons formed for the promotion of a joint enterprise join in common purpose, or to join in an action. produce income jointly. It is not enough that the persons receive the income jointly. The liability to tax depends upon the earnings of profits by a unit and not upon its ultimate division Two or more persons associate themselves; Joint and several liability resulting in the sharing of profits and losses 37

38 KEY PROVISIONS Section Sec. 2(31) Sec. 6(2) Sec. 40(ba) Sec.67A Particulars Definition person Residential status of AOP Remuneration to the members of AOP Method of computing a member s share in the income of association of persons or body of individuals Sec.86 Sec.167B Sec. 110 Share of member of AOP taxability Charge of tax where share of member's in association of persons or body of individuals unknown AOP taxation Rebate, if any in the hands of the members of AOP 38

39 DEFINITION OF PERSON SECTION 2(31) The term person is defined under section 2(31) of the Act to include an AOP Finance Act, 2002 brought a clarification by inserting an Explanation to section 2(31), which provided that an AOP shall be deemed to be a person, whether or not it was formed or established or incorporated with the object of deriving income, profits or gains What are we discussing? Why Amendment? Prior to 2002, certain bodies claimed that they did not fall under the definition of person due to sole reason that they were not formed with the sole intention of having any income or profits or gains. How does it impact? Thus, earning of income, profits or gains by a combination of person could no longer be regarded as a pre-requisite for the combination of persons to be considered as an AOP 39

40 SECTION 2(31) OBJECT OF DERIVING INCOME NOT NECESSARY? Controversy? Finance Minister Speech The advisory group has also recommended deletion of various exemptions granted to incomes of approved or notified bodies or institutions, including educational and medical institutions. I do not think that the exemptions allowed to these institutions and bodies, which are fulfilling social objectives, should be withdrawn. However, I propose to require all such bodies and institutions to file returns of income every year so as to enable a periodical verification of whether the prescribed conditions, which primarily relate to application of the income, are being fulfilled and also to enable the prescribed authority to withdraw the approval or notification of such entities if they are found to have violated any such conditions. Memorandum and notes to clause 3 are reproduced below: It is proposed to insert an Explanation in the said clause (31) of the said section so as to provide that an association of persons or a body of individuals or a local authority or an artificial juridicial person shall be deemed to be a person, whether or not, such person or body or authority or juridicial person was formed or established or incorporated with the object of deriving income, profits or gains. 40

41 SECTION 2(31) OBJECT OF DERIVING INCOME NOT NECESSARY? Circular 8, Under the existing provision contained in clause (31) of section 2, the expression "person" includes an individual, a Hindu undivided family, a company, a firm, an association of persons or a body of individuals, whether incorporated or not, a local authority and every other artificial juridical person, not falling within any of the above definitions. Although, the definition of "person" is inclusive and starts with the qualifying words "unless the context otherwise requires", in some cases, a claim has been made that certain bodies do not fall within any of the definition of "person" provided in clause (31) of section 2 due to sole reason that they are not supposed to have any income or profits and gains. To clarify the correct legal position, an Explanation in clause (31) of section 2 has been inserted through Finance Act, 2002 so as to provide that an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not, such person or body or authority or juridical person, was formed or established or incorporated with the object of deriving income, profits or gains. 41

42 MEMBERS OF AOP JUDICIAL PRECEDENTS A Limited Company with other companies (in Joint venture) can be members of AOP Ganga Metal Refining Co (P) Ltd Ltd 67 ITR 771 (Cal) Minors can be members of AOP but with consent of lawful guardian G. Murugesan & Bros (1973) 88 ITR 432 (SC) A Co-operative society can be member of AOP Salem District Urban Bank Ltd (1940) 8 ITR 269 (Mad) Two or more individuals obtaining benefit of commission on sales can constitute an Association of Persons Sunil Krishna Paul (1969) 71 ITR 618 (Cal) The erstwhile partners of a firm, (where the firm and all its partners were declared insolvent and the firm was dissolved but the business of the firm was carried on by the receiver appointed by the court) can constitute an Association of Persons. In such a case, the assessment of erstwhile partners of a firm has to be made in the status of an AOP George Talkies Circuit (1988) 171 ITR 386 (Raj) Joint ownership of properties by two persons, receiving income jointly without any joint efforts cannot form AOP Gool C. Dalal & Perin C. Dalal 184 ITR 248 (KAR) 42

43 RESIDENTIAL STATUS OF AOP The residential status of the AOP would determined on the basis of place of control and management of AOP Control and Management Situated wholly or partly in India Situated wholly outside India AOP would be treated as Indian tax resident - worldwide income liable to tax in India AOP would be treated as Non-Resident - Only Indian income liable to tax in India

44 Residential Status of AOP What constitutes control and management of affairs Control and management means controlling and directive power. It means de facto control and management and not merely the right to control or manage Nandlal Gandalal (1960) 40 ITR 1 (SC) The word affairs means affairs which are relevant for the purposes of the Act and which have some relation to income V.V.R.N.M. Subbayya Chettiar (1951) 19 ITR 168 (SC) Control and management of the affairs of assessee in the relevant year is material and not in any subsequent or earlier accounting period Sri Raja K. V Narasimha rao Bahadur (1950) 18 ITR 181 (Mad) SO WHAT IF AOP IS CONSTITUTED? Discussed in next few slides

45 Disadvantages/ practical challenges where AOP constituted Loss incurred is not available for carry forward once the AOP is ceased to exist. Further, the members shall not be eligible to claim the losses of the AOP No clarity on whether benefits under the tax treaty are available to AOP Salary, bonus, remuneration paid to members shall be disallowed [section 40(ba)] Credit against advance taxes paid by members may not be available to the AOP Disadvantages of AOP Where costs are incurred by the members individually, the following challenges shall arise: - Accounting of such expenses; & - Allowability of such expenses The AOP shall be required to obtain a PAN in its name, maintain books of accounts, comply with the withholding tax provisions, file return of income and pay advance taxes Depreciation on assets owned by the members would not be available to the AOP as members of AOP may not be regarded as owners of the assets Though the share of income earned from the AOP is not taxable in the hands of individual members, the same is included while computing book profits under MAT. This could lead to double taxation where individual members are taxable under MAT

46 Other ISSUES AND CONCERNS Tax inefficiencies in case the of AOP taxation: Worldwide income may be taxable in the hands of the AOP on net basis however members share of profit will be exempt in the hands of the respective members; AOP exposure in EPC contracts (discussed in subsequent slides) Rate of tax percent, if one of the AOP participant is a foreign company Whether the share of the members of an indeterminate AOP is exempt in the hands of the members? Whether credits should be given to AOP where TDS certificate are in the name of the members? treaty benefits jeopardized; inability of consortium partners to carry forward and set off losses of consortium; availability of tax credit in Home country could be an issue for Foreign members Income from the entire contract (including offshore supplies) may be taxed on net basis however if the payments to member of the AOP for the offshore supplies are deductible in the hands of the AOP (subject to section 40 (ba) of the Act), the same may not be taxable in the hands of the members since title of the goods transfers outside India; 46

47 ISSUES AND CONCERNS Lack of clarity on exchange control regulations in setting up a AOP (which has a non-resident member); DDT is not applicable; MAT would not be applicable. However AMT is applicable, Transfer Pricing regulations would be applicable for international transactions between the AOP and the members; Practical issues / difficulties under exchange control regulations in repatriation of post tax profits to foreign members; The assignees would need to be in the payroll of AOP practical issues in obtaining Visa for assignment of employees Under the Direct Tax Code, 2010 ( DTC ) the AOP would be taxed at 30 percent Payments to members in the form of FTS, interest on debts etc would be an allowable deduction while computing the taxable income of the AOP 47

48 Computation of member s share of income(s.67a) Section 67A of the Act provides for the following methodology for determining the share of a member in the income of an AOP when the share of each member is known and determinate: Step 1- Compute the income of the AOP in accordance with the provisions of the Act Step 2- Payments of the nature specified in section 40(ba) of the Act are deducted from the amount determined at Step 1 above. The balance amount will be apportioned between the members in their profit sharing ratio Step 3- Payments of the nature specified in section 40(ba) of the Act are added to the amount determined at Step 2 above to arrive at the share of a member in the income of an AOP EPC Contracting in India 48

49 Allowability of expenses Section 40 ba Any payment by way of interest/ salary/ bonus/ commission/ remuneration to any member of AOP is not allowed as deduction in the hands of AOP [section 40(ba) of the Act] If the AOP receives as well as pays interest to its members during the previous year then the excess interest paid over and above the interest received shall be disallowed. The above provisions shall not apply Where an individual is a member in his individual capacity and receives interest by such individual from AOP on behalf of any other person(karta of HUF). Where an individual is a member on behalf of or for the benefit of any other person (karta of HUF) and is paid to members other wise than in his representative capacity. (Refer issues and concerns for detailed discussion)

50 TAXABILITY OF AOP AND ITS MEMBERS in a nutshell Share of Members are determinate Scenario Rates of Tax for AOP Share of Member None of the members have income in excess of maximum amount not chargeable to tax(covered by finance act slab rates Section 167B not applicable) Any of the members have total income (before including their share from AOP) exceeding maximum amount not chargeable to tax(section 167B(2)(i)) Any of the members having total income chargeable to tax at a rate higher than MMR(Section 167B(2)(i)) Rates applicable to individual Maximum Marginal Rate (MMR) To the extent of that member's share, such higher rate and balance at MMR Shares of members to be included in their total income. Rebate under section 110 can be claimed(section 86 Proviso clause (b)) Shares of the members not to be included in their total income (section 86 clause(a)) Shares of the members not to be included in their total income (section 86 clause(b))

51 TAXABILITY OF AOP AND ITS MEMBERS Share of Members are Indeterminate The shares of Members of an AOP in the whole or any part of the income of the AOP is deemed to be indeterminate or unknown, if such shares (in relation to the whole or any part of such income) are indeterminate or unknown on the date of formation of the AOP or at any time thereafter. Tax is chargeable on the total income of the AOP at MMR Where any member of the AOP is subject to a rate higher than the MMR, tax is chargeable on the total income of the AOP at such higher rate

52 Dissolution/Discontinuance of AOP Section 177 of the Income Tax Act The Assessing officer shall make the assessment of AOP, disregarding the discontinuance or dissolution. All provisions including penalty provisions shall apply Member of the AOP or the legal representative of a deceased member shall be jointly and severally liable for tax and penalty. If the AOP is discontinued during the assessment proceedings, then such proceedings shall be continued against the persons referred above from the stage as it stood at the time of disallowance. If notice is served on one of the members of AOP, assessment shall be valid.

53 Illustrations

54 SECTION 167B not applicable Share determinate and known AOP Resident Individual A Resident Individual B Taxable Income of Members ( excluding share of income from AOP) A Rs 200,000 B Rs 225,000 54

55 SECTION 167B(1) Share indeterminate and unknown AOP Indian Co Resident Individual 55

56 SECTION 167B(1) - Proviso Share indeterminate and unknown AOP Indian Co Foreign Co Resident Individual 56

57 Section 167B (2)(i) Share determinate and known AOP Resident Individual A Resident Individual B Income of AOP Rs 500,000 Taxable Income of Members ( excluding share of income from AOP) A Rs 3,00,000 B Rs 40,000 57

58 SECTION 167B(2)(ii) Share determinate and known AOP Indian Co Profits of the AOP = Rs 600,000 Foreign Co Resident Individual 58

59 Section 86 Proviso 1 clause(a) Share determinate and known AOP Resident Individual A Resident Individual B Profits of AOP Rs 500,000 Taxable Income of Members ( excluding share of income from AOP) A Rs 3,00,000 B Rs 40,000 59

60 SECTION 86 Proviso 1 Clause (a) Share determinate and known AOP Indian Co Profits of the AOP = Rs 600,000 Foreign Co Resident Individual 60

61 SECTION 86 proviso 1 clause (b) Share determinate and known AOP Income of the AOP Rs.6,00,000 Resident Individual A Resident Individual B Taxable Income of Members ( excluding share of income from AOP) A Rs 200,000 B Rs 225,000 61

62 SECTION 86 Proviso 2 Share determinate and known AOP Income of the AOP Rs.1,60,000 Resident Individual A Resident Individual B Taxable Income of Members ( excluding share of income from AOP) A Rs 200,000 B Rs 225,000 62

63 Numerical illustrations IPL Associates has two members RR(40%) and CSK(60%) Income of IPL associates for the year 7,00,000 for AY Compute the taxable profits of member of AOP a) RR and CSK have their income other than AOP income respectively as Rs.1,00,000 and Rs.3,50,000 b) RR and CSK have their income other than AOP income respectively as Rs.1,00,000 and Rs.2,00,000 EPC Contracting in India 63

64 Numerical illustrations (a) Particulars IPL RR CSK Status AOP Individual Individual Income Add: Share income of AOP 8,00,000 NA 1,00,000 Nil* 3,50,000 Nil* Total Income 8,00,000 1,00,000 3,50,000 Tax computation Tax on total income Less: Rebate u/s87a Tax payable Add: 2% Add. ( x 30%) 2,40,000 NA 2,40,000 4,800 2,400 Below BEL Nil Nil Nil Nil Nil ( )*10% 10,000 5, Total Tax Payable 2,47,200 Nil 5150 *Note: Since one of the member s income exceeds the Basic Exemption Limite(BEL),the income of the AOP is charged to MMR(Section 167B(2)(i). Consequently share of income from members is not included in the total income of members as per Section 86 Proviso 1 Clause (a) EPC Contracting in India 64

65 Numerical illustrations (b) Particulars IPL RR CSK Status AOP Individual Individual Income Add: Share income of AOP 8,00,000 NA 1,00,000 3,20,000 2,00,000 4,80,000 Total Income 8,00,000 4,20,000 6,80,000 Tax computation Tax on total income Less: Rebate u/s87a Tax payable Add: 2% Add. TOTAL TAX Average rate of tax Share income x AR Rebate u/s 110 slab rates 75,000 NA 75, ,250 NA NA NA Slab rates 17, , , % 3,20,000 x 2.94% 9408 Slab rates 51,000 NA 51, ,530 Total Tax after rebate 77, , % 4,80,000 x 7.73% *Note: Since none of the member s income exceeds the Basic Exemption Limit(BEL),the income of the AOP is charged to rates as per finance act(s167b not applicable). Consequently share of income from members is included in the total income of members as per Section 86 Proviso 1 Clause (b) EPC Contracting in India 65

66 Numerical illustrations Compute the share income of Mr.XY Mr.XY is a member of two AOPs namely XXX & CO and XY & AB XXX & co have income chargeable at normal rates of tax(finance act rates). Implies Other members of XXX does not have income chargeable at normal rates of tax. Mr.XY receives interest of Rs.3,00,000, salary of Rs.1,50,000, share income of Rs.1,00,000 XY & AB owns a house property jointly(share equally) in Chennai. Interest on borrowed capital Rs.6,00,000. House property is self occupied 66

67 Numerical illustrations Paticulars Amount in Rs. Amount in Rs. Income from House Property Net annual value Less: Deduction u/s 24(5,00,000 x 50%) (restricted to 2,00,000) Profits and gains from business or professions(income from AOP) Salary Interest Share income Goss total income Less: Chapter VIA deductions Total income Tax on total income Less: Rebate under section 87A Tax after rebate Edu.cess@2% Hsc.cess@1% Tax payable Average rate of tax(total tax payable/total income)=3.43% (6,50,000 x 3.43%= 22,295)(rebate restricted to 15,450) Net tax payable NIL 2,00,000 2,00,000 4,00,000 1,50, ,000 6,50,000 4,50,000 NIL 20, (15450) NIL EPC Contracting in India 67

68 Numerical illustrations Inferences Under Section 26, Where the house property is owned by two or more persons whose share is definite and ascertainable, the income from such property shall be taxed in the individual assessment of members. The deduction under section 24 is available to each co owner indepently. Since the AOP is chargeable to tax at normal rates, the member is eligible for rebate under section 110 EPC Contracting in India 68

69 ISSUES AND CONCERNS

70 ISSUES AND CONCERNS Deductibility of expenses incurred by members of the AOP The terms interest, salary, bonus, commission or remuneration have not been defined under the Act. Further there are few judicial precedents with regard to Section 40(ba) of the Act. However, rationale of the same can be drawn from judicial decisions on the erstwhile section 40(b) of the Act that impose a similar restriction in the case of payments made by a partnership firm to its partners. Complete prohibition on deduction The Madras High Court in the case of R. A. Goodsir And Company, Madras vs CEPT (16 ITR 367) which involved payment of commission by a firm to its partners has held that the prohibition under section 40(b) of the Act is absolute in terms and makes no distinction on the basis of the nature of payment and/ or the capacity in which the payment is received by the partner. A similar view has been taken by the Karnataka High Court in Mysore Bangle Works v. CIT (157 ITR 411), EPC Contracting in India 70

71 ISSUES AND CONCERNS Deduction available to members for services rendered not in the capacity of member The Madras High Court in Commissioner of Income Tax vs. Chitra Kalpana (169 ITR 678) held that where ever a partner is under a legal obligation to provide his services or capital and yet charges for such services and capital, the payment made cannot be allowed while computing the firm s income because of section 40(b). The High Court also considered the case of a partner having vacant premises in which the business of the partnership firm could be run. It observed that surely the partner is not bound to gratuitously allow the building to be used by the firm or its business. He is not bound to provide his premises free of rent. If the firm occupies a property belonging to a partner and pays rent, such payment of rent is not made impermissible as deduction under section 40(b) of the Act. Thus wherever a partner is under a legal obligation to conduct the partnership business or provide capital for the business, the amounts paid to him by way of salary, bonus, commission or other remuneration and interest are made impermissible as deduction in computing the firm's income. Further where he is not under a legal obligation, the payments may be permissible. EPC Contracting in India 71

72 ISSUES AND CONCERNS However this view was distinguished by In the case of CIT v Rajam Ramaswamy & Sons (2008) 298 ITR 325 (Mad.), the High Court has held that where payments made to partners were not in their capacity as partners but were made for the specific services rendered by them, the payments could not be disallowed following the decisions Chitra Kalpana (Supra) and CIT vs Gemini Productions (110 ITR 847). This view was again however not accepted by the Gujarat High Court in CIT vs Yoganand Textiles (202 ITR 869). The High Court held that to the extent expenditure is incurred by a partner in respect of work done for the firm, the provisions of section 40(b) of the Act will not be attracted. It is only the net remuneration in the hands of the partners which will attract the restrictions laid down in section 40(b) of the Act and not the entire amount paid to the partner. In another decision, the Bombay Tribunal has held in the case of Inspecting Assistant Commissioner vs. Indian Lime Corporation (8 ITD 908), that reimbursement of expenses incurred by a partner company in providing its staff members to the assessee firm could not be treated as remuneration paid by the firm to its partner within meaning of section 40(b) of the Act. EPC Contracting in India 72

73 ISSUES AND CONCERNS 40(A)(2) vs 40(ba) It may also be pertinent to note that section 40A (2) of the act also prescribes that payment made by an AOP to its members, etc would be disallowed to the extent it is considered as excess or unreasonable by the assessing officer. The above section supports the view that not every payment made by an AOP to its members would be hit by the provisions of section 40(ba). Considering the above judicial precedents, deduction can be claimed for payments made to members provided it is demonstrated that the: Expenditure is incurred on behalf of the AOP and Reimbursement is on a cost - to - cost basis and does not include any element of profit. Any profit element will however be disallowed under section 40(ba) of the Act. Having mentioned the legal position, it is relevant to mention that the tax authorities might take a contrary view and hold that that the payments to the members by the AOP is in the nature of appropriation of profits and would thus not be eligible for deduction. The matter is not free from doubt and may involve litigation in view of the conflicting decisions of the various courts. EPC Contracting in India 73

74 ISSUES AND CONCERNS 44C vs AOP The deduction under section 44C of the Act, which is available only to a non - resident entity, is restricted to 5% of the adjusted income or the actual expenses which ever is lower. No deduction is available in the event the non-resident entity has a taxable loss. As stated this deduction is available only to non-resident entities. Since the residency status of the AOP would be that of a resident (wherein the entire control and management is not outside India), head office expenses incurred by the Head offices of the members of the AOP will not be deductible in computing the profits of the AOP. EPC Contracting in India 74

75 ISSUES AND CONCERNS MAT Provisions on members of AOP The share of profits from the AOP will have to be considered while preparing the annual accounts of the constituent member companies. Even though the share of profits is not taxable, the same will have to be considered in computing the book profits of the company member as required under section 115JB of the Act. In some cases this can lead to double taxation of the same income in two hands, once in the hands of the AOP under the normal provisions of the Act and again in the hands of the constituent members under the provisions of the MAT, if their income tax liability under MAT (after inclusion of share of income from the AOP) exceeds income tax payable under the normal provisions of the Act. EPC Contracting in India 75

76 ISSUES AND CONCERNS Set off and carry forward of losses of an AOP Under the provisions of the Act business loss can be carried forward for eight tax years while unabsorbed depreciation can be carried forward indefinitely to be set off against income under the respective head. The business loss and unabsorbed depreciation can be carried forward only in the hands of the AOP and not in the hands of the constituent members. In this connection the findings of the ITAT Kolkata Bench E in the case of Birla Tyres Vs. Jt. CIT (88 ITD 1) are relevant. In this case the Tribunal on a careful examination of the section pertaining to the set off and carry forward of losses, the definition of an assessee and person in the Income-tax Act and the contents of Circular 551 issued by the CBDT came to a conclusion that the assessee being a member of an AOP is not allowed to set off the share of loss suffered by the assessee in the AOP. This has an adverse affect on some of the members of the AOP, which may have other income taxable in India, as they will not be able to offset the loss incurred by them in the project against their taxable profits earned from other sources in India. EPC Contracting in India 76

77 AOP EXPOSURE IN EPC CONTRACTS

78 RECENT TRENDS: TAX RISKS It is a common practice in India now days that Companies join hands to execute big projects. In such cases contract is awarded to a consortium working together under an overall co-ordination/ consortium agreement. An overall umbrella agreement or performance guarantee is given by the consortium leader for successful completion of the project. The need for having a Consortium arises due to the following reasons Complexity and magnitude of projects (e.g. EPC contracts) Different technical capabilities required Time constraints for project completion Better co-ordination / management of the Project (e.g. Turnkey contracts) Regulatory requirements for minimum net worth, requirement of Indian partner, etc (e.g. PPP) The courts have analysed some of the clauses of the agreement which provided as under: Each member has unrestricted access to any work carried out by the members in connection with the Project and shall assist each other in the completion of the work. The JV members are jointly and severally liable for the satisfactory execution and completion of the work in all respects 78

79 RECENT TRENDS: TAX RISKS In the event of insolvency of a member, the other members are irrevocably appointed to act for that member the agreement also provides for reassignment of work by the other members in case a member commits substantial breach of its obligations. The sum received by JV towards payment for the work done by defaulting member shall be used to compensate any loss/damage resulting from the default of that member Based on above the courts have held the relationship between the parties brings an AOP into existence and the income would be taxed accordingly. Accordingly, it is important to ensure that scope of work of the parties to the consortium is clearly defined and each partner is responsible for its respective scope of work and agree to bear their own cost or retain their profits separately. It should be specifically mentioned in the agreement that the intention of the parties is not to carry on business in common with the other parties with a view to profit and that it is their intention to utilize the consortium safely for the better cooperation with the customer and the division of the work and income under the contract. Further, it should be ensured that there is no common control or connection between the works to be done by the consortium members. 79

80 EPC ACTIVITIES AND REVENUE STREAMS Activities envisaged under a typical EPC contract Classification of revenue streams Offshore supply of equipment, materials Offshore supplies Offshore design, project management & control Offshore services Onshore supply Onshore supplies Onshore civil/ non-civil works- unskilled Onshore installation services - skilled Local services Onshore technical services In subsequent slides, we have given a snapshot of the taxability of each component in a typical EPC contract Cross border EPC contracts Key income tax issues 80

81 CBDT INSTRUCTION 1829 WITHDRAWAL Taxability of turnkey contracts considered in Instruction No 1829 [1989] Instruction 1829 recognised Consortium structure for execution of large contracts Coordination agreement to ensure guaranteed performance Taxability of multiple scope /multiple contractors on stand-alone basis Limited reach was issued for hydro-electric power project Withdrawn wef July 2009 [after favorable AAR ruling in Hyosung Corp case] Cross border EPC contracts Key income tax issues 81

82 CBDT INSTRUCTION 1829 WITHDRAWAL (CONT) CBDT Instruction 1829 Key features Instruction discussed taxability in case of the following: Consortium of companies involved in executing individual scopes of work Presence of coordination agreement to ensure guaranteed performance Accrual of income from equipment sale on FOB basis if title passes outside India, not deemed to accrue or arise in India - existence of overall coordination agreement not to impact this taxability Planning, design and engineering services rendered in India / abroad to be taxable as FTS as per the provisions of the Act / treaty not liable to be taxed as Royalty Clubbing of distinct scope of work Though originally intended for turnkey hydro-power project, taxpayers rely on the Circular while executing other projects Cross border EPC contracts Key income tax issues 82

83 Circular No.7 of 2016 dated March 7,2016 CBDT lays down criterion where consortium of contractors formed for executing EPC / turnkey contracts will not be treated as Association of Persons (AOP) for taxation purposes; CBDT specifies 4 attributes of consortium arrangement wherein it will not be treated as AOP (1) Where each member is independently responsible for executing its part of work through its own resources, (2) each member earns profit or incurs losses based on performance of the contract falling strictly within its scope of work, (3) men and materials used for any area of work are under the risk and control of respective consortium members and (4) control and management of the consortium is not unified and common management is only for the inter-se coordination between the consortium members for administrative convenience. The Circular also states that there may be additional factors, depending upon specific facts of a particular case, which will need to be considered while taking a view in the matter. EPC Contracting in India 83

84 Circular No.7 of 2016 dated March 7,2016 It has been further clarified that the Circular would not be applicable to cases where all or some of the consortium members are Associate Enterprises (AEs) as per Indian Transfer Pricing regulations. Such cases will be decided by the Tax Officer in view of relevant provisions of the Domestic tax laws and judicial precedents in this regard. Key Takeaways The issue of AOP taxation has been a contentious issue with several judicial precedents1both,in favour and against the taxpayer(s). The issue is generally decided on the basis of specific facts of each particular case Taxpayers were relying on the judicial precedents pronounced for determination. Even though the circular would provide a broad guidance on deciding the criteria for AOP, it has given the scope for tax authorities to decide the cases where AE s are involved. EPC Contracting in India 84

85 Case study ABC US Outside India Offshore Supplies & Offshore Services AOP/ Consortium India Customer Onshore Supplies Onshore Services XYZ India EPC Contracting in India 85

86 Case study The implications if the structure (Consortium of ABC US & XYZ India) is considered as a resident AOP: Entire profits (including offshore supplies) would be 42.23% where the share of the members is indeterminate Any other income (not related to India) from activities carried out by the consortium may be covered under the tax net, AOP being a resident entity There would be restriction on the charges by members to the AOP (section 40(ba) of the Act) There would be difficulty in claiming the credit of taxes paid by AOP in the hands of foreign members Non-availability of treaty benefits to the foreign members MAT provisions may lead to double taxation in certain cases Benefit of set off/ carry forward not available to individual members EPC Contracting in India 86

87 Case study S. No Clause reference Facts of the Case- Risk of AOP Facts of the Case- May not exist 1 Intention clause Intention of the JV members to collaborate for all the work associated with the project, which is to be managed on a joint basis by all the members. 2 Demarcated revenue streams Payments are made to the account of JV for all the services rendered by it as per the payment schedule. Each of the parties expressly agreed that it is not their intention through the joint venture to carry on business in common with the other parties with a view to profit. Further, intention of the parties is to utilize the joint venture safely for better co-operation of their relationships with the employer. The revenue stream for each party was clearly defined. Paid separately to the Bank account of each of the members. EPC Contracting in India 87