Govt brings much needed clarity in taxation of consortiums; Infrastructure developers to benefit

Consortium structures, wherein multiple companies come together to execute large scale infrastructure contracts are becoming increasingly common because such contracts are too large and complex for a single party to undertake alone. The consortium members usually have very clearly defined independent work scopes and are responsible for their own profits, losses and taxes thereon.

Getting these structures accepted for the purpose of taxation, however, has remained a challenge. The taxman contends that (i) such structures constitute a single independent taxable entity known as an Association of Persons (AOP); and (ii) that the profits cannot be assessed in the hands of each consortium members individually. This results in a proverbial 'perfect storm' for the consortium members as it usually results in estimation of income taxable in the hands of the AOP by the taxman which is then charged to tax at the highest rates. Additionally, benefits such as carry-forward and set-off of losses is also not available to the consortium member partners.

The problems are accentuated for the members who are foreign companies because their non-resident tax status in India become ineffectual (an AOP is taxed as an Indian resident if at any time during the relevant year the management and control is situated in India). This means that the foreign companies cannot claim benefits of taxes paid in India in their home country.

Legal eagles have had a field day with litigation being rampant on the issue. There have been conflicting judgments in favour of and against the taxpayers from the Authority for Advance Rulings and the High Courts.

The government has been doing a lot of hard work in trying to reduce litigation in tax matters as has been evident from the various circulars and clarifications issued recently. Continuing this trend, the Central Board of Direct Taxes (CBDT) has issued detailed guidance in Circular no. 07/2016 clarifying that under the following circumstances, consortium structures will not constitute an AOP for tax purposes:

Complete demarcation should exist in the scope of work of each consortium member and each member should bear risks and costs of only their relevant scope of work;

There should be no intention of earning joint profits. Each member should earn profits or incur losses based on the performance of their relevant scope of work. Sharing of contract price at gross level to facilitate convenience in billing is permitted; Assets deployed for performance of the contract are not used jointly, but under the risk and control of the respective consortium member; and There is no common control and management of the consortium except for administrative convenience.

Depending upon the facts of the case the tax officer can also take into account other factors for determining whether or not a consortium structure is to be taxed as an AOP; The circular will not be applicable to consortiums where all the members are related / associated enterprises.

While the guidance issued by the CBDT is based largely on the principles set in the various Court rulings that were delivered in favour of the taxpayers, it will serve to drastically reduce litigation in consortium structures. CBDT circulars are binding on the tax officers and we may see appeals by the tax authorities in various courts being withdrawn and appellate orders in favour of the taxpayers not being litigated by the tax authorities any further. Taxpayers, in the meantime, will be able to operate with increased confidence.

For too long, tax tangles have fueled uncertainty in the business environment deterring foreign investment in Indian projects. Meanwhile, the government has benefited very little in terms of tax collections because in the final result, the taxpayer has won in appeals. It is heartening to see that the government is increasingly identifying genuine problems faced by the taxpayers and taking concrete steps to address them in a meaningful manner. This should augur well for India's future.

The writer is a partner-International Taxation, Nangia & Co