In a recent decision(1) – one which is likely to have an impact on jointly executed turnkey contracts in India – the Delhi High Court held that the mere presence of multiple entities in joint execution of an agreement does not constitute an 'association of persons' and thus cannot be taxed as a separate taxable entity. Delivered in the background of two entities jointly executing a turnkey contract (using both offshore and onshore supplies and services), the court emphatically rejected the stance of the Income Tax Department (ITD) that creation of a consortium by joint executors is sufficient to discard the separate taxable status of the entities and the contention that the consortium is to be assessed as an association of persons under the Income Tax Act 1961.
Linde AG (a German company) had formed a consortium with Samsung Engineering (a South Korean company) to bid jointly on a turnkey basis for ONGC Petro Additions Limited to undertake the following:
"Executing the work (including undertaking all activities and rendering all services) for the design, engineering, procurement, construction, installation, commissioning and handing over of the plant for the Dual Feed Cracker and Associated Units of Dahej Petrochemical Complex."
The ITD treated the consortium as constituting an association of persons, which the two entities resisted. The entities approached the Authority for Advance Ruling (AAR) to obtain a ruling on the correctness of the ITD's stance. In its ruling, the AAR confirmed the ITD's stance, taking the view that "the Contract was an indivisible contract and was incapable of being split up into different components / parts" and thus concluded that all income received and receivable by the parties to the consortium – even for offshore supply of equipment, materials and spares and for offshore supply of drawings and designs relating thereto – was taxable in India by virtue of the parties to the consortium constituting an association of persons.
The AAR's ruling was brought before the Delhi High Court (by way of writ petitions). While there were a number of issues raised before the court, only one has been categorically answered (the rest having been remitted back to the AAR for a factual inquiry):
"whether the consortium formed by Linde and Samsung constitutes an Association of Persons under section 2(31) of the Act and are liable to be taxed under the provisions of the Act as an Association of Persons."
Referring to earlier decisions on this aspect, the court held that:
"the Association of Persons is one in which two or more persons join together for a common purpose or common action and there is a joint management or joint action by the said two or more persons. In order to treat persons as an association, it is necessary that the members must have a common intention and must act jointly for fulfilling the object of their joint enterprise."
Further, extending relief to the entities jointly executing the agreement, the court held that mere commonality of purpose or action does not imply taxability as an association of persons, and held that it was instead:
"necessary to consider the extent and the nature of the common purpose and the common action, in order to determine whether the said persons form an association for the purposes of imposing tax or not."
To conclude on whether an association of persons was created, the court declared that the following essential and cumulative features must be satisfied:
"(i)There must be two or more persons.
(ii)The constituent members must have come together for a common purpose.
(iii)The association must move by common action and there must be some scheme of common management.
(iv)The cooperation and association amongst the constituent members must not be perfunctory and / or merely in form. The association amongst members must be real and substantial which is sufficient to treat the association as a separate homogenous taxable entity."
Given the position of the parties, the court held that "allocation of the work was done in such a manner that each member was required to perform work which was within its field of expertise and could not be performed by the other party", and that the "work to be performed by both the members was separate, definite and divisible"; thus, "as far as execution of the project was concerned, each party had to work independent of the other".
The court also noted that "the consideration for the work performed was to be made directly to the concerned member of the Consortium in accordance with the work performed by him", and that there "was no arrangement for sharing of profits and losses between Linde and Samsung". Therefore, the facts did "not indicate a sufficient degree of joint action between Linde and Samsung either in execution or management of the project to justify a conclusion that they had formed an Association of Persons".
This decision is of critical significance to taxpayers – particularly those involved in providing offshore supplies to India because most Indian service recipients insist on a joint bid by consortium, even if the offshore and onshore supplies may be from different legal entities.
The ITD has taken the view that whenever a joint bid is submitted, the different legal entities separately become liable to tax in India as an association of persons on the entire income arising from the jointly executed contract, even though such entities may not be related in any other manner, and individually may not be taxable in India. This is particularly true for oil and mineral gas exploration companies and other large-scale infrastructural projects where – in view of the quantum of specialised supplies and services required for such projects – they invariably necessitate a bid by consortium, with joint and several liabilities of the bidding and executing parties. It is hoped that the clarity on the legal concepts rendered by the Delhi High Court will assist both the parties and the ITD to minimise litigation and resolve similar issues.
The court's observation regarding what does not constitute an association of persons is particularly encouraging:
"in every project which is executed by multiple independent agencies, a certain level of cooperation and coordination is required to ensure that the agency involved performs its work in a timely manner as per a predetermined schedule in order to enable the other agency to commence and complete its portion of work."
Such factors, in the absence of an "element of mutual agency and joint action" do not constitute an association of persons.
These findings will go a long way to dispel the ITD's terse stance that any mutual interest or common objective is sufficient to treat entities as having formed an association of persons, which must be taxed as such.
The court also observed that the AAR should have been consistent in its approach and, since it had already held in similar circumstances that an association of persons was not established (eg, in Hyundai Rotem), it was bound to apply its earlier ruling in the absence of any change in legal position. This impetus on consistency should serve as a beacon against unwarranted deviations by the tax administration.
This decision is likely to provide clarity in the indirect tax arena, particularly customs and service tax, where similar issues are frequently agitated to deny tax benefits (eg, in Gammon India (2011 Supreme Court decision) and New Horizons (1998 Supreme Court decision)) on the premise that the consortium and joint venture led to changes in the entities' legal status.
With the Supreme Court's declaration to this effect (ie, in Columbia Sportswear 2012), parties can now approach the high court by way of writ petition in order to challenge an AAR ruling and to obtain an expedited review. The Delhi High Court's decision is a quintessential reflection of this.
For further information on this topic please contact Ranjeet Mahtani or Divya Jeswant at Economic Laws Practice by telephone (+91 22 6636 7000), fax (+91 22 6636 7172) or email (email@example.com or firstname.lastname@example.org).