Further, the government is considering reforming and promoting the 'Public Private Partnership' model. In such a scenario, the role of the foreign investors with expertise and skill in the execution of such projects cannot be overruled. The uncertainty surrounding the taxability of the income arising from such contracts is still continuing and will need to be addressed to promote participation of foreign players.
The Engineering, Procurement and Construction ('EPC')/ turnkey contracts are complex and involves high cost. Typically, complex portion requires technical expertise and thus for a foreign investor having such expertise. Indian company generally fills up for the local expertise and skill requirements. Both together form a consortium to bid for the work. Each party is jointly and severally liable to the contractee but at the same time there is a demarcation in their scope of work, risk, responsibilities and liabilities.
The issue of the aforesaid consortium forming an Association of Persons ('AOP') under an EPC contract has been a matter of dispute between the tax authority and the tax payer for quite some time. Under the provisions of the Indian tax law, if a consortium is treated as an AOP, then the entire income, including the income arising from offshore supply and services would be taxable in India.
In this context, the Authority for Advance Ruling ('AAR') in its various rulings viz. Geoconsult ZT GmbH, Alstom Transport SA andCTCI Overseas Corporation Limited has held that a consortium formed to execute an EPC contract would constitute an AOP. However, the AAR has taken a contrary view in the case of Hyundai Rotem Co. and Mitsubhishi Co., Hyosung Corporation and so on.
Recently, the Delhi High Court (HC) had decided the issue in favour of the taxpayer in the case of Linde AG and held that a consortium would not be taxable as an AOP. The HC, based on various judicial precedents, has laid down the following essential features of an AOP:
-Must be constituted by two or more persons.
-The constituent members must have come together for a common purpose.
-The association must move by common action and there must be some scheme of common management.
-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.
On perusal of the submissions put forth by the taxpayer, the HC had held that the consortium could not be taxable as an AOP since there was no joint management, action or purpose. Moreover, there was a clear demarcation in the scope of work, payments, risk and costs between the consortium members.
Useful reference can be had to instruction number 1,829 dated September 21, 1989, issued by Central Board of Direct Taxes. It had laid down guidelines on taxability of non-residents engaged in the execution of power projects on a turnkey basis. One of the clarification provided was that the consortium formed for execution of power projects would not be taxable as an AOP even though different foreign entities were entrusted with different jobs under supervision and coordination of one entity. However, the instruction was subsequently withdrawn in 2009, which added to uncertainty on what constitutes an AOP.
In light of the above, insertion of definite provisions on the taxability of consortiums is the need of the hour. It is imperative that the forthcoming budget provides clarity on the taxation of such consortium and taxability of such transactions in the hands of the foreign investors operating in the EPC sector. It may be useful to clarify in the law itself as to what does not constitute an AOP as it was done earlier vide the aforementioned instruction. This will also be in line with the commercial understanding of the parties that each one is responsible for their share of work alone. Explicit and clear tax laws on this issue would act as an impetus for the foreign investors who have the necessary expertise and technology to participate and execute large EPC contracts in India.
Vikram Doshi is Partner - Tax, KPMG in India