Careful structuring reduces tax on foreign companies

By Sumes Dewan, and Shradha Puri, KR Chawla & Co
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The Authority for Advance Rulings (AAR), in the matter of Geoconsult ZT, recently passed a judgment stating that a joint venture consortium between a foreign company and Indian companies could be treated as an association of persons (AOP) in consonance with section 2(31) of the Income Tax Act, 1961, and taxed as a foreign company at a 41% net basis.

Sumes Dewan Partner KR Chawla & Co
Sumes Dewan
Partner
KR Chawla & Co

In the above-mentioned case, the applicant, Austria-based Geoconsult, formed a joint venture consortium (JV) with two Indian companies for the purpose of providing project consultancy services in India to Himachal Pradesh Road and Other Infrastructure Development Corporation (HPRIDC).

HPRIDC awarded a contract to the JV led by Geoconsult to provide consultancy services for the development of specific tunnels in Himachal Pradesh.

According to the contract agreement, members of the JV were jointly and severally liable to HPRIDC. The contract also stated that payments made to the JV would be divided, with half of the total fees awarded to Geoconsult and the other half shared between the Indian JV members.

Geoconsult was required to carry out geological and technical investigations, field surveys, the collection of seismological data, and surveys for establishing topographical conditions.

It was necessary for these activities to be carried out at the project site by a team of ten technical personnel deployed by Geoconsult and such services would require their residency in India for a sufficiently long period of time. In addition, since Geoconsult along with other JV members was managing day-to-day activities on a regular basis, the authorities believed it was difficult to imagine that the company could carry out its services without a permanent establishment (PE) in India.

The jurisdictional commissioner therefore held that Geoconsult had a PE in India, and that the fees received from HPRIDC were thus taxable in India as “profits and gains of business”.

The issue that arose from the said case was whether the JV constituted an AOP under section 2(31) of the act and was liable to be taxed in India, in accordance with the view that Geoconsult had been permanently established in the country.

The AAR ruled that the present case had all the essential elements of an AOP. In line with section 2(31) of the act, the key ingredients of an association are i) two or more persons; ii) voluntary combinations; iii) a common purpose or common action with the object to produce profits or gains; iv) a combination in the form of a joint enterprise; and v) some kind of scheme for common management. However, the object to produce profits or gains was no longer a sine qua non with the insertion of the explanation in clause 31 to section 2 of the act.

In the contract between HPRIDC and the joint venture members, it was stipulated that each member of the JV would be jointly and severally liable to HPRIDC for the performance of work and the contract price would be paid to the JV.

Shradha Puri Senior associate KR Chawla & Co
Shradha Puri
Senior associate
KR Chawla & Co

Furthermore, the agreement executed between the JV members outlined that members of the JV would collaborate on all the work associated with the consultancy service for the project.

The JV clearly reflected the key ingredients of an AOP and was thus taxable under that classification at the rate of 41% net basis.

In light of the above judgment, it is clear that the foreign companies in India should structure their investments carefully in order to reduce their tax liability.

In the present case, a foreign company had entered into a JV with two other Indian companies to provide consultancy services, but it was found that the foreign company had a PE in India. As a result of its activities, the JV was hence constituted as an AOP.

The arrangement between the JV members gave sufficient indication of a combination of three entities with the common objective of executing work and producing income from the venture.

Thus, as a precautionary measure foreign companies making investments in India must be careful when entering into a consortium with other Indian companies.

If the arrangement between the parties has any resemblance to an AOP, and the foreign company’s income in India is attributable to a PE, then the foreign company is liable to pay 41% tax.

Foreign companies keen to invest in India are recommended to carry out their businesses through a wholly owned subsidiary company or a joint venture incorporated entity to reduce their tax liabilities in India.

Alternatively, a consortium may be structured in a way which provides adequate safeguards and in no manner indicates the presence of an AOP.

Sumes Dewan is a partner and Shradha Puri is a senior associate at KR Chawla & Co Advocates & Legal Consultants. The firm is headquartered in New Delhi and has offices in Chennai and Bangalore as well as a representative office in Singapore.

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