India Tax: AAR ruling illustrates factual drivers in finding an Association of Persons

The Indian Authority for Advance Rulings (AAR) issued an important ruling on 23 March 2010, concluding on the basis of the facts of the case that members of a consortium formed by foreign companies and other entities would not be treated as an Association of Persons (AOP) for Indian income tax purposes (M/s Hyundai Rotem Co., Korea vs. DIT and M/s Mitsubishi Co., Japan v. DIT, AIT-2010-115-AAR).

The existence of an AOP is an important issue in India because, if a consortium is treated as an AOP, all income from the project for which the consortium is formed is taxed in the hands of the AOP as a single taxable unit. In contrast, if the consortium is not treated as an AOP, each member of the consortium is individually liable to pay tax on its share of the income. The tax treatment in the two instances may differ in terms of the tax rate, the ability to set off losses, application of the minimum alternate tax and the availability of tax treaty benefits.

Although the Indian Income Tax Act does not contain a definition of an AOP, the Supreme Court and other courts have defined it as an association of two or more persons that join for a common purpose or action with the objective of producing income, profits or gains. The courts have also held that there is a distinction between "earning of income jointly" and the "receipt of income jointly" – the former may constitute an AOP for income tax purposes, but the latter may not.

The AAR has examined the AOP issue in a number of cases involving consortiums with foreign companies, reaching different conclusions based on the relevant facts in the cases. In a ruling issued in 2000 (Van Oord Acz BV), the AAR applied the above principles and concluded that a joint venture (JV) between the foreign applicant and an Indian company did not constitute an AOP. Significant factors leading to the AAR's conclusion included: the applicant and the Indian company had agreed to separately bear their own loss or retain their own profits; the parties had agreed to execute the job together for better cooperation; and the applicant's association with the Indian company was not with the objective of earning income but for the coordination of work in executing the contract.

However, in a ruling issued in 2008 (GeoConsult ZT GmbH), the AAR distinguished the Van Oord case on its facts and held that the consortium, of which the applicant was a member, constituted an AOP. The AAR noted in GeoConsult that the "unity" between consortium members does not break down merely because gross revenue is shared and not profits, i.e. sharing in profits and losses is not an essential prerequisite of an AOP. The facts that led to the AAR finding an AOP in GeoConsult included: the JV partners had "associated" themselves with a "common design" to provide consultancy services; the contract was between the JV partners and the Indian contractor and the payments were received by the JV as a unit; and the JV partners were jointly and severally liable to the Indian contractor. The AAR also observed that a demarcation of duties does not in any way affect the integrity of the association but is only an internal arrangement based on the expertise or experience of each of the members and for the convenient execution of the project.

In the 2009 case of Hyosung Corporation, the AAR observed, among other points, that: the relationship between the foreign applicant and an Indian company was merely a collaboration for execution of the project; the Indian contractor awarded separate aspects of the contract to the two entities; each party performed its obligations separately and received the amounts payable thereon independent of each other; the individual identity of each entity was preserved; and the supervisory role assigned to the applicant was in the overall interest of the project. On the basis of these facts, the AAR distinguished GeoConsult and ruled that the foreign applicant and its Indian counterpart did not form an AOP.

In the instant case, Hyundai Rotem (Rotem) and Mitsubishi Co. (MC), along with Mitsubishi Electric Corporation, Japan (MELCO) and BEML Limited, India (BEML), formed a consortium for the design, manufacture, supply, testing, commissioning, training and transfer of technology of 156 Standard Gauge Electrical Multiple Units to Delhi Metro Rail Corporation (DMRC). The four members entered into a Consortium Agreement that set out the specific responsibility of each member, with: Rotem responsible for mechanical works; MELCO for electrical works; BEML for localization works; and MC for project coordination, commercial management, contract administration, legal administration, providing bank guarantees and collecting payments from DMRC in its capacity as consortium leader. The participation percentage of each member was separately identified in the Consortium Agreement, which was subsequently revised by a Supplementary Consortium Agreement.

The consortium signed a contract with DMRC under which a single lump sum consideration and various milestones were stipulated, with the consideration apportioned among various cost centers. All members of the consortium were jointly and severally liable for the completion of the contract.

The AAR held that, based on an overall evaluation of the facts and circumstances, it was unable to conclude that the consortium could be treated as an AOP. The AAR observed that the factors against the existence of an AOP outweigh the factors in support of an AOP. The AAR concluded that the facts in the case before it were more in line with the Van Oord case rather than GeoConsult.

While a ruling of the AAR is applicable only to the particular applicant(s), the ruling does have persuasive value. The AAR ruling in this case is significant as the AAR carried out a detailed and thorough analysis of the facts presented and, on that basis, concluded that the consortium did not form an AOP. It is pertinent to note that the AAR acknowledged that even a few differences in facts can make a difference in determining whether an AOP has been created. Another important point is that, although the contract with DMRC indicated a single lump sum consideration, the AAR took note of the fact that the income of each member was separately identified in the Consortium Agreement / Supplementary Consortium Agreement, notwithstanding the fact that DMRC was not a signatory to these agreements.

To sum up, it is crucial for foreign entities and their Indian counterparts forming a project consortium in India to be aware that they could unintentionally create an AOP, with specific tax consequences including the availability of tax treaty benefits.