DIRECT TAX LAWS TAX ISSUES IN THE HANDS OF AN AOP 2. Same have been shown in the Table below: Tax Residency and Taxability of an AOP Deduction of expe

DIRECT TAX LAWS Vodafone Hangover - Taxability of offshore transactions in India SILVIA RAJPAL CA INTRODUCTION 1. A joint venture is one of the most widely used vehicles of commerce which can be categorized mainly either as an incorporated joint venture or as an unincorporated joint venture. In case of an incorporated joint venture the shares of the JV are held by its members and it is treated as any other incorporated company for the purpose of taxation. On the contrary, an unincorporated JV has no legal existence. Parties create a consortium and enter into inter-party agreements to jointly bid for the works and give it the characteristic of a turnkey contract. The contracts are awarded to the consortium considering the technical skills and competence of its members to undertake the work. The members hold defined rights and obligations in the consortium agreement which specifies, inter alia, the role of each member in the consortium. A consortium of members meeting essential characteristics is granted an independent status under the Income Tax Act, 1961 ( the Act ) and treated as an Association of Persons ( AOP ). There is no specific definition of an AOP under the Act. However, section 4 of the Act imposes tax on income earned by a person in the previous year. Further, section 2(31)(v) of the Act includes an AOP in the definition of a person. There has been prolonged uncertainty and ambiguity on whether the unincorporated JVs and consortiums would be treated as AOPs. In this connection an advance ruling presented on March 20, 2012 in the case of Linde AG, Linde Engineering Division [2012] 19 taxmann.com 238 (AAR- New Delhi), has sought guidance in terms of relevant factors and circumstances when unincorporated JV or a consortium shall be treated as an AOP. Prior to the analysis of the aforesaid ruling, it may be pertinent to mention the tax issues in the hands of an AOP. May 1 to 15, 2012 u TAXMANN S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 19 17

DIRECT TAX LAWS TAX ISSUES IN THE HANDS OF AN AOP 2. Same have been shown in the Table below: Tax Residency and Taxability of an AOP Deduction of expenses Minimum Alternate Tax Set off and carry forward of losses As per section 6(4) of the Act, an AOP shall not be treated as a resident in India only if the control and management of its affairs is wholly outside India during the year. The presence of non-residents in the consortium would not automatically lend the non-residential status to the AOP. In case an AOP qualifies as an Indian tax resident, the worldwide income of AOP shall be subject to tax in India. The contract shall not be dissected 1 for the tax purposes and even the offshore transactions shall fall within the tax net. Further, the usual treaty benefits are also not available to the non-residents. The profits of an AOP are taxed on net income basis as per the provisions of the Act. However, section 40(ba) of the Act imposes restrictions on allowability of payments made towards interest on loan or capital, salary, bonus, commission or remuneration made by an AOP to its constituent members. The intent of imposition of the aforesaid restriction is the prevention of reduction of tax liability of an AOP by siphoning off its income given to its members. MAT provisions are not applicable to an AOP. However, the aforesaid provisions may be applicable in determining the taxable profits of their members. As per section 167B, read with section 86 of the Act, the share of member shall not be included in the total income in case the AOP is taxed at maximum marginal rate or at any higher rate. On the contrary, the share of member would be considered while computing book profits of the member companies. This would lead to double taxation of same income in two hands, i.e., AOP as well as the member companies. As per the provisions of the Act, business losses are allowed to be carried forward and set off for 8 years. Unabsorbed depreciation can be carried forward indefinitely for any number of years. In case of an AOP, business loss and unabsorbed depreciation can be carried forward only in the hands of an AOP. Its members cannot claim the benefit of carry forward and set off of the losses incurred by an AOP against their other business income. 2.1 Critical examination of these factors - Understanding the repercussions of a consortium qualifying as an AOP, as mentioned in the table above, critical examination of the factors and circumstances which would lead to an unincorporated JV/a consortium to be an AOP is very important. As mentioned supra, the analysis of the Advance Ruling in the case of Linde AG, Linde Engineering Division (supra) would help in determining such factors and bring clarity to the picture of formation of an AOP. 3. ANALYSIS OF AAR S RULING IN THE CASE OF LINDE AG, LINDE ENGINEERING DIVISION 3.1 Key Issue before AAR - It is pertinent to bear in mind that the key issue before AAR was the taxability of offshore activities in India. 3.2 Key Facts of the Case before AAR 3.2.1 Formation of the consortium - The applicant, Linde Engineering Division, Germany formed a consortium with Samsung Engineering 18 May 1 to 15, 2012 u TAXMANN S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 20

Company Ltd., Korea ( Samsung ) to take up the work being awarded by ONGC Petro Additions Ltd. ( OPAL ) for the designing, engineering and installation of a plant on a lump sum turnkey basis. 3.2.2 Parties liable jointly and severally - Both the parties, i.e., the applicant and Samsung entered into the Memorandum of Understanding ( MOU ) followed by the Internal Consortium Agreement ( ICA ) separating their area of operations and responsibilities. The payment was also agreed to be made separately to each member based upon the allocated work. The parties were liable jointly and severally for the obligations of the project with reference to the specified terms and conditions. 3.2.3 Model followed by Consortium - The model followed by the consortium was very simple. The allocation of work to its constituent members was done based on their area of expertise. The payment was also made by OPAL directly to the members of the consortium for the work performed by each of them. Following is the diagrammatical representation of its Modus Operandi: 3.2.4 AAR s ruling sought on two aspects of taxation in India - The applicant approached AAR, to seek ruling on the following matters: (i) Whether the applicant and Samsung are taxable in the status of an AOP under the Act? (ii) Whether the payment received in respect the offshore transactions would be taxable in India? 3.3 Applicant s Contentions - 3.3.1 Consortium as a divisible contract - The contract entered into between OPAL and the consortium was a divisible contract which identified the terms of scope of work, obligation of the members of consortium and the consideration payable directly to each member. 3.3.2 Consideration for offshore transactions not taxable - The contract could be split into separate parts following the decision of Ishikawajama Harima Heavy Industries Limited v. DIT 2 and, thus, the consideration for offshore transactions was not taxable in India. 3.3.3 Expenses incurred by each member - The expenses were exclusively incurred by each member for the part of the work performed by that member. May 1 to 15, 2012 u TAXMANN S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 21 19

DIRECT TAX LAWS 3.3.4 Issues not involved in the case - The sharing of the profits and losses, the assets, capital employed or resources were not involved. 3.3.5 Title to machinery in off-shore area - The title to machinery supplied by the applicant to OPAL had passes off in the off-shore area. 3.4 Revenue s Contentions - 3.4.1 Contract a lump-sum turnkey contract - The Revenue contended that the contract was a lump sum turnkey contract and was indivisible. A contract had to be read as a whole to understand its purport and effect. Therefore, the income of the non-resident by way of royalty/ fee for technical services would be deemed to have accrued or arisen in India and, thus, had to be included in the total income of nonresident, even if the services of the non-resident were not rendered in India 3. 3.5 AAR s observations and ruling - 3.5.1 Consortium jointly and severally liable - AAR observed that the Consortium was jointly and severally liable to perform its obligations. The performance guarantee was also furnished by bank on behalf of the consortium. Further, it was observed that by setting aside the payments member-wise could not alter the nature of the contract in the context of the tender and the work undertaken. 3.5.2 Splitting-up the contract would be artificial - AAR held that the aforesaid contract for erection and commissioning of plant also includes delivery of design and machinery. The risk is retained even beyond the delivery of the equipment, i.e., up to trial, commissioning and acceptance of the project, unlike the sale of goods contract. It was further held that any splitting up of the aforesaid contract, considering the sale of goods separate from obligation undertaken for erection and commissioning, would be artificial. 3.5.3 Approach must be to understand the nature and object of contract - The AAR relied on the Supreme Court s judgment in Vodafone International Holdings B.V. v. Union of India [2012] 17 taxmann.com 202 wherein it was held that it is the task of the Revenue/Court to ascertain the legal nature of the transaction and while doing so, it has to look at the transaction as a whole and not to adopt a dissecting approach. Therefore, a dissecting approach from the angle of taxation should not be resorted to and the approach must be to understand the nature and the object of the contract by looking at the transaction. 3.5.4 Situs of the contract - AAR held that the fact of offshore supply of design or machinery alone could not be the driver to determine the situs of the contract. Rather, the situs of the erection contract had to be determined on the basis of the site where the plant was to be erected. Since the contract was signed in India, it was held that the situs of the contract was in India. Further, it was held that the sale of machinery and designing of the project and equipment could not be treated as offshore transactions. Therefore, taxing the aforesaid was not beyond the jurisdiction of the Indian Revenue authorities. 3.5.5 No mention of off-shore/on-shore supply - AAR also considered the Revenue s contention that the contract did not specify that title to the machinery shall pass on to OPAL on high seas or in the country of origin. There was no mention of off-shore or on-shore supply of services. 3.5.6 Main purpose of the MoU other than to supersede nature of contract - AAR also held that ICA cannot be referred to interpret the contract or rights and obligations thereunder. It was merely an internal arrangement between the members of the consortium and even OPAL was not a party to it. Further, the purpose of the MoU was merely to bid for and secure the contract. Therefore, MoU could not be understood to supersede the nature of the contract. The segregation of the duties and the payment for the work done by each member would not dislodge the legal position of formation of AOP. 20 May 1 to 15, 2012 u TAXMANN S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 22

CONCLUSION 4. AAR concluded that AOP was formed based upon various judicial precedents 4. After considering the above mentioned reasons along with the fact that two entities came together as a consortium with a common object of bidding for work, AAR ruled that responsibility was that of the consortium for establishment of the project and the members carried joint liability which continued after installation and even after commissioning. 5. KEY DO S AND DON TS - POST LINDE - CONSORTIUM AGREEMENT* S.No. Do s Don ts 1. Contract must be a divisible contract backed Contract should not be a consolidated contract with by ample justification for splitting up the a consolidated price. contract and not merely for tax consideration. 2. The role and responsibility of the members The obligation for performance of the contracts of the consortium should be clearly should not be a joint liability. In case of joint and demarcated. several liability of the members, a member who makes up for any contractual defaults should have right to be indemnified by the defaulting member. 3. Scope of work and the payments for the A lump sum contract amount for the entire work work done should be clearly demarcated. should not be agreed to. The members should indeed be directly paid, for the work performed by each of them. 4. Performance guarantee should be issued by Performance guarantee should not be issued by the members of the consortium for their bank on behalf of the consortium. respective work under the contract. 5. Title to offshore supply of equipments It should be specified that the title to machinery should pass outside India. shall pass on to the company awarding the contract on high seas or in the country of origin. 6. Relationship between parties and the object Relationship between parties and the object of the of the consortium should be specified to be consortium should not be to conduct business mutual cooperation for execution of the together. contract. *Subject to commercial viability 1. Vodafone International Holdings BV v. UOI [2012] 341 ITR 1/17 taxmann.com 202 (SC) 2. [2007] 288 ITR 408/158 Taxman 259 (SC) 3. Explanation to section 9(2) of the Act 4. CIT v. Indira Balkrishna [1960] 39 ITR 546 (SC); G. Murugesan & Brothers v. CIT [1973] 88 ITR 432 (SC); Hyundai Rotem Co., Korea/Mitsubishi Co., Japan, In re [2010] 323 ITR 277/190 Taxman 314 (AAR - New Delhi) May 1 to 15, 2012 u TAXMANN S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 23 21