A joint venture, perhaps one of the most widely used vehicles of commerce, is principally of two types – an incorporated joint venture [“IJV”] and an unincorporated joint venture [“UJV”]. The shares of the IJV are held by the members of the joint venture, in proportions that typically reflect their respective contributions to the enterprise. As a matter of law, therefore, an IJV is treated as any other incorporated company. A UJV, on the other hand, is a creature of contract, and has no separate legal existence. Members of the joint venture create rights and obligations through a consortium agreement that defines the role that each member plays in the enterprise. The considerations that affect this choice are many, and the obvious benefit of an IJV’s separate legal existence is often offset by the tax obligations it generates, and by company legislation to which it becomes subject.
A UJV, however, raises many legal questions that have not yet been fully answered in India. For example, there are doubts over the validity of a shareholder’s agreement that restricts the right of a joint venture member to a third party, although such agreements essential to a joint venture. It was likewise with qualifying criteria such as experience, until the Supreme Court settled the question in New Horizon.
In this connection, an interesting question arose last week before the Authority for Advance Rulings [“AAR”], in the context of the Income Tax Act, 1961 [“ITA”]. The decision is Hyundai Rotem Co. v. DIT, and is available here. The Delhi Metro Rail Corporation [“DMRC”] had invited bids for design, supply and manufacture of Electrical Multiple Units. The winning bid was submitted by a consortium that comprised four members – Mitsubishi Corporation (Japan), Hyundai Rotem (Korea), Mitsubishi Electric (Japan) and BEML Ltd. (India). The relationship between the consortium members was governed by two agreements, known as the Consortium Agreement [“CA”] and the Supplementary Consortium Agreement [“SCA”], and a single contract was entered into with the DMRC.
Rotem filed an application before the AAR asking whether the members of the consortium would be assessed as “individual” companies, or as an “association of persons”. An association of persons is considered a taxable entity under s. 2(31) of the ITA. The expression, however, is not defined in the ITA, and tests to determine its existence have been evolved judicially. Some decisions held that an association of persons must have as its object the sharing of profit or gain. In 2002, however, an Explanation was inserted to s. 2(31) stating that an association of persons shall be deemed to be a person “whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits and gains”. Two decisions of the AAR – Van Oord Acz BV and GeoConsult ZT GmbH – added to the difficulty. In Van Oord, the AAR held that the UJV in question was not an association of persons, while it held in GeoConsult that it is, since the sharing of profit is not an essential ingredient of an association of persons. In Hyundai Rotem, the AAR had to decide whether the UJV structure in the case was closer to Van Oord or to GeoConsult. For three reasons, the AAR decided that the UJV structure in Rotem did not constitute an association of persons.
First, the nature of the work or function assigned to each UJV member under the CA and the SCA was substantially different. Mitsubishi Corporation was appointed, for example, as the Consortium Leader and charged with overall responsibility, legal concerns, collecting payments etc. Mitsubishi Electric was charged with the electrical component of the project, Rotem with the mechanical component, and so on. The AAR held that this prevents the “interchangeability” or “re-assignment” of work, which it considered a useful test to distinguish between an association of persons and a collection or group of individuals falling short of it. Secondly, the SCA specifically provided that “nothing in the Agreement is intended or shall be construed as creating a partnership, joint venture or any other legal entity among the parties”. Thirdly, the UJV members individually presented invoices to DMRC, and incurred no common expenditure. None of these factors had existed in GeoConsult. The Agreement had provided specifically that its object was to create an unincorporated association, and the function of each member was entirely interchangeable with the function of another. In particular, a breach of the agreement by one member could lead to the reassignment of that member’s role in the agreement to another, and members were jointly and severally responsible for each other in the event of insolvency.
It is clear that analysing the nature of a UJV is no easy task. Hyundai Rotem, however, demonstrates that the most useful method of approaching this question is likely to be a careful analysis of the particular agreement, and a comparison of that agreement with other cases.