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Contract receipts of a JV result in diversion of income to JV members; receipt not an income of the JV
In a recent decision of the Jammu and Kashmir (J&K) High Court (“HC”) in the case of Soma TRG Joint Venture6 (“the Assessee”). The HC, in this case, was concerned with the issue of whether the contract revenue received by a joint venture (JV) accrues as income in its hands or whether it results in diversion of income at source from the JV to the JV members.
An Indian company (“A Co.”), wanted to bid for a tender floated by the Indian Railways for construction of tunnels. However, the Indian Company did not satisfy the conditions which were laid out by the Indian Railways in the tender notice. Another Indian company (“B Co.”), had the necessary experience which would make it eligible to bid for the tenders floated by the Indian Railways. Thus, both (JV members) entered into a JV agreement to set up a JV with the intention of filing a joint bid for the tender floated by the Indian Railways.
As per the JV agreement, B Co. would act as the lead party of the JV. Furthermore, both A Co. and B. Co. would jointly exercise the authority to incur liabilities on behalf of the JV. As per the terms of the existing JV agreement, the JV members entered into a new JV agreement, neither B Co. nor the JV was required to do any work in relation to the contract.
Owing to the limited role of B Co., the JV members agreed to share the contract revenue in the ratio of 97:3.
In the relevant financial year (FY), the contract revenue was allocated by the JV to A Co. and B Co. in the ratio of 97:3 and the JV filed a return of income in the status of AOP and declared nil income for the relevant FY by contending that the income from the contract was diverted to the JV members at source and there was no accrual of income in its hands. The JV members offered the contract revenue to tax in the agreed ratio. However, the Tax Authority treated the contract revenue as income of the JV. Furthermore, the Tax Authority considered the payment made by the JV to JV members as payment towards sub-contracting charges. Since the JV had failed to withhold taxes on the same, the Tax Authority disallowed the payment made to the JV members under the disallowance provisions.
Aggrieved by the orders of the appellate authorities, the Assessee appealed before the HC.
Ruling of the HC
On diversion of income at source
The terms of the JV agreement indicate that the JV was formed only for the purpose of submission of the tender bid and once the contract was awarded, work was executed by the JV member. The JV has not performed any work or activity in relation to the contract. The amount received by the JV is, thus, not an income accruing to it. The primary test for determining whether there has been a diversion of income is to determine whether the income gets diverted before it accrues to the taxpayer or whether it is applied by the taxpayer after it accrues to it.
Though the definition of income is very wide, in the facts of the case, income from the contract is diverted at source itself before it accrues to the JV. Hence, it cannot be regarded as income of the JV.
Applicability of the disallowance provisions
The HC referred to the Supreme Court (SC) ruling in the case of R.B. Jodha Mal Kuthiala7 in support of the proposition that a provision which is inserted in the Act to rectify an unintended consequence and to make the provision workable, is to be treated as having retrospective application. Basis this, the HC held that the amendment to the disallowance provisions is curative and is retrospective.
In the present case, the JV members have paid the taxes on the income received. The case is protected by the amended disallowance provisions. Alternatively, the disallowance provisions will apply only to an amount which remains unpaid at the end of the relevant FY and will not apply to an amount which is already paid during the FY. In the present case, there is no amount payable to the JV members at the end of the relevant FY and, hence, there can be no disallowance in the hands of the JV.
There has been an ongoing litigation on the issue of whether, in a case where there is internal overriding understanding between members, the principles of diversion of income by overriding title apply to the AOP
Furthermore, whether such principles can be drawn by the AOP to contend that income received from the contract is diverted at source in favor of the members which executed the contract and, hence, such receipt should not constitute income in its hands.
The judicial precedents on this aspect indicate that the primary test for determining whether there has been a diversion of income is to determine whether the income gets diverted before it accrues to the assessee or whether it is applied by the assessee after it accrues to it.
To that extent, this HC ruling does provide some guidance to assessees on the circumstances in which a consortium may claim that the amount received by it is diverted in favor of its members.