Association of persons: transparency at last

An unincorporated joint venture, commonly referred to as a consortium, is a creation of contract and has no separate legal existence. Parties to a consortium typically create rights and obligations through a consortium agreement that defines the roles of the members of the consortium.

Infrastructure ventures

For infrastructure projects, entities come together to form consortiums to bring different skill sets together or in order to meet the eligibility criteria set out by tender documents such as net worth, technical capabilities, experience of similar projects, O&M experience, etc.

A problem with consortiums has been that they are often held to be ‘association of persons’ (AoP), a term which is used in the Income Tax Act, 1961, but has not been defined. What constitutes an AoP has been surrounded in uncertainty, but a recent ruling of the Authority of Advanced Rulings (AAR) in M/s Hyundai Rotem Company, Korea and Another v DIT has substantially clarified this grey area in the Income Tax Act.

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The Hyundai case

In response to a tender floated by the Delhi Metro Rail Corporation (DMRC), a consortium agreement was entered into between Mitsubishi Corporation, Japan, Hyundai Rotem Company, Korea, Mitsubishi Electric Corporation, Japan and BEML Limited, India.

The relationship between the consortium members was governed by two agreements, a consortium agreement and a supplementary consortium agreement, and a single contract was entered into with the DMRC. The agreement provided for strict segregation of the scope of work and responsibilities for each member in accordance with their respective skill sets.

The AAR ruled that such a consortium agreement would not constitute an AoP under the Income Tax Act for the following reasons:

(a) Segregation of scope of work between the members was based on their respective skill sets whereby such work could neither be assigned to another member nor could it be supervised by another member in the event of a default by one of the members. This prevented the “interchangeability” or “re-assignment” of work, which constitutes an important test to distinguish between an AoP and individual entities.

(b) The members had agreed to share in a pre-decided ratio and be responsible for their respective profits, losses and expenditures while raising separate invoices for their respective works or supply components.

(c) Members had submitted separate guarantees and undertakings to the DMRC from their respective parent companies for their segregated scopes of work.

(d) The consortium agreement was entered into only for the purpose of participating in the tender process and clearly stipulated that the members did not intend to constitute a joint venture or a partnership.

Wider ramifications

The tests laid down by the AAR provide significant clarity. In addition it should ease tax concerns of foreign companies that are considering becoming members of bidding consortiums in India, as being treated as an AoP creates a substantially greater tax liability.

An AoP is regarded as an Indian tax resident where even a part of the control and management of its affairs is situated in India while foreign companies are regarded as Indian tax residents only where the whole of the control and management of their affairs is situated in India. Indian tax residents are taxed on their profits which might have accrued outside of India and thus, a foreign company, which is a part of an AoP, would be taxable in India even in respect of offshore supplies.

This will not be the case where foreign companies are taxed independently. Further, it is relatively easier for an independent foreign company to take advantage of tax credits under a double taxation avoidance agreement, as compared to a foreign company which is a part of an AoP.

In addition, one of the reasons for splitting of EPC contracts has been the apprehension that the contractors, under a single contract, maybe construed to be an AoP. This concern has now been removed.

The Hyundai case is another step in the recent judicial trend towards providing clarity on taxation issues, particularly in the infrastructure field. It should help clear the uncertainty surrounding what constitutes an AoP and this will be good news for the buoyant Indian infrastructure market.

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Akshay Jaitly is a partner and Amar Narula is an associate at the Delhi office of Trilegal. Trilegal is a full-service law firm with offices in Delhi, Mumbai, Bangalore and Hyderabad. The firm has over 120 lawyers, some of whom have experience with law firms in the US, the UK and Japan.