The increase in the number of large infrastructure projects in the country to meet the demand for development of infrastructure has led to a significant increase in the number of Equipment Procurement and Construction (EPC) contracts. These EPC contracts typically involve various entities across the globe. Due to the requirement of expertise, and specialised resources in each specific area of such EPC contracts and turnkey projects, entities participating in EPC contracts usually form a consortium to represent a single point of contact for the client.
Typically, in EPC contracts and turnkey projects, each member of the consortium would be jointly and severally liable to the client despite having a clear distinction in role, scope of work, responsibilities and labilities inter se the consortium members. This has given rise to a number of tax disputes, where the tax authorities have mooted that a consortium constitutes an ‘Association of Persons’ (AoP) and should be chargeable to tax as such. This creates an exposure for the consortium AoP i.e. the joint venture, to be treated as a person ‘resident in India’ in which case global income of such joint venture would be taxed as its ‘business income’ in India, in certain cases at the rate applicable to a non-resident entity, i.e. 40% (plus applicable surcharge and cess). This results in higher tax incidence on the income of the consortium and its resident and non-resident members. No treaty benefit reduces this tax incidence. AoP is not defined under the Income Tax Act, 1961 (IT Act) and judicial precedents have some overlapping and conflicting guidance on determination of AoP. With a view to address this issue and bring certainty to the taxability of EPC contracts, the Central Board of Direct Taxes (CBDT), apex body governing the direct taxes under the Ministry of Finance, has now issued a circular 07/2016 (dated 7 March 2016) (Circular).
Circular issued by the CBDT
The Circular clarifies that if a consortium arrangement has certain attributes such as the following, it may not be treated as AoP:
Clear demarcation of scope of work and associated costs: Each member of the consortium is independently responsible for executing its part of the work through its own resources. The consortium members should also bear the risk and expenses related only to such specified scope of work i.e. a clear demarcation in the work and costs between the consortium members;
Profits/loss based on scope of work: Each member earns profits/ incurs losses based on performance of the contract strictly falling within its scope of work, the consortium members may however share a contract price for the purpose of facilitating convenience in billing;
Risk and control of resources: The labour and materials used for any area of work are under the risk and control of the respective consortium members;
No unified control and management of the consortium: The control and management of the consortium is not unified and common management is only for coordination between the consortium members for administrative convenience.
The Circular also recognises that there may be additional attributes which may demonstrate that the consortium is not an AoP, depending on the specific facts and circumstances.
Further, the Circular will not apply to consortiums where all or some members are ‘Associated Enterprises’ (AE). AE, for this purpose, would be the same as that under transfer pricing regulations. This would inter alia include a situation where a consortium member participates directly or indirectly in the control, management or capital of other member of the consortium. In such cases, the tax authorities will rely on the provisions of the IT Act and judicial precedents to decide whether or not an AoP is constituted.
The Circular brings welcome clarity and it reinforces the Government’s commitment towards a non-adversarial tax regime in India. It provides a breather to the infrastructure sector, especially non-resident companies who are members of a consortium, as the risk of AoP always loomed over the parties forming a consortium to undertake EPC contracts and turnkey projects. The clarification contained in the Circular would serve as a guiding light to the income tax authorities, and thus reduce inconsistency in the approach adopted by them while evaluating consortium structures.
Majority of the large EPC contractors have Indian subsidiaries. Hence, not excluding related parties/AE would have brought much more clarity to this vexatious issue of AoP exposure on EPC contracts.