A large number of foreign companies take up projects in India in association with other companies. For this purpose, quite frequently, foreign companies enter into a joint venture (JV) or a consortium agreement.
Till recently, the interpretation of the income-tax law of India has been that if the joint venture or consortium agreements properly define the scope of work of each member and if the amount payable to each member is also clearly indicated, and the amount is directly paid to each member against the invoices raised by the member, the income-tax liability of each member to the agreement will be determined separately and individually.
However, in a recent case of Geoconsult ZT GMBH, the Authority for Advance Ruling (AAR) has pronounced a ruling on July, 31, 2008 which will seriously upset the legal interpretation of such agreements.
An Austrian company formed a consortium with two other Indian companies to provide project consultancy services to HPRIDC in Himachal Pradesh.
The Austrian company rendered almost all the services from Austria; it has neither a ‘fixed place of business nor an office’ in India; it does not also perform any substantial activity in India; the employees are also not deputed in India for a considerable length of time; it does not have a ‘permanent establishment’ (PE) in India. Therefore, the income received by the JV constitutes “fees for technical services” (FTS) and should be subjected to tax in accordance with article 12 of the DTAA, i.e., @ 10 per cent.
A ruling was sought from the AAR. The department was of the view that the applicant has a PE in India since the office of the JV is situated in India and also a team of personnel is deputed for project by the foreign company to India. The fee received by the Austrian company is attributable to such PE and is thus taxable in India as “profits & gains of business and profession” under article 7 of the DTAA. Further, the status of the JV should be treated as an “association of persons” (AOP).
The AAR finally observed that “the essential features and stipulations in the two agreements coupled with the background in which the joint venture was formed overwhelmingly point out the existence of ‘association of persons’ as it is understood in law and in ordinary parlance. Common purpose and common action pursued towards the ultimate end of earning income/profits is writ large on the face of the agreements…………the J.V. is to be taxed in the status of an association of persons @ 41 per cent net basis.”
To avoid the constitution of AOP by a JV, certain points may be useful. There should be a clear demarcation of duties between the members of the JV; the members should not be jointly liable for the execution and completion of the work; the members should independently coordinate with the clients in respect of their field of work, the JV should not have a unified management; there should be restricted access to the work carried out by other members; unity of action and common management should not exist; consolidated invoicing should be avoided, i.e., each member should raise the invoices separately to the client so as to avoid sharing of gross remuneration in any agreed proportion.
It is quite clear now that Consortium Agreements need to be very carefully drafted to avoid formation of AOP which is liable to tax in India at maximum marginal rate of tax.