I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s

MB I B 0 4 ( U n i t I I I )

Page 1
Tax Treatment of Joint Venture Agreement

A joint venture is subjected to taxation under the provisions of Income Tax Act, 1961. It is the
umbrella Act for all the matters relating to income tax and empowers the Central Board of Direct
Taxes (CBDT) to formulate rules (The Income Tax Rules,1962 ) for implementing the provisions
of the Act. The CBDT is a part of Department of Revenue in the Ministry of Finance. It has
been charged with all the matters relating to various direct taxes in India and is responsible for
administration of direct tax laws through the Income Tax Department. The Income Tax Act is
subjected to annual amendments by the Finance Act, which mentions the 'rates' of income tax
and other taxes for the corresponding year.
Taxation of a joint venture depends upon the agreement between the parties, forming the joint
venture. If the joint venture is established in the form of a partnership firm or as a company, it is
taxed accordingly i.e. as a partnership or as a company. But in all other cases, a joint venture is
treated as an association of persons (AOP) or a body of individuals (BOI).
An Association of Persons (AOP) means two or more persons who join for a common purpose
with a view to earn an income. The term 'person' includes any company or association or body
of individuals, whether incorporated or not. The association need not be on the basis of a
contract. Therefore, if two or more persons join hands to carry on a business but do not
constitute a partnership they may be assessed as an AOP. But, an AOP does not mean any and
every combination of persons. It is only when they associate themselves in an income-producing
activity that they become an association of persons.
Body of Individuals (BOI) means a conglomeration of individuals who carry on some activity
with the objective of earning some income. It would consist only of individuals. Entities like
companies or firms cannot be members of a body of individuals. Income tax shall not be payable
by an assessee in respect of the receipt of share of income by him from BOI and on which the tax
has already been paid by such BOI











I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( Un i t I I I )

Page 2
Tax Implication of Joint Ventures


I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 3
Key Consideration in Deal structuring











Choice of Jurisdiction

Taxability of Distribution of Dividends,
In Indian context, any Jurisdiction is tax neutral due to the fact that DDT @ 16.995% is
levied upon the distributing company

Capital Gains

Capital Gains would arise upon the sale of the investment in India. Thus, this aspect concerns
the exit option for the investor. In the Indian context, gains made on the sale of investment
attracts a capital gain tax of 20% if the holding period of the asset is less than 3 years and 10% if
the holding period exceeds 3 years.
In view of the same, the investment can then be structured through a holding company set up at
a location where such gains are exempt.

Interest on Debt funding

Interest on debt funding is a very critical part of the entire transaction

The tax deductibility of these expenses is critical, since this would result in a considerable
amount of savings

Choice of
juridiction
(Taxability of)
Dividend
Capital Gain
Interest on
debt funding
Investment
Vehicle
Regulations
Tax
considerations
Funding
Options
Equity
Preference
Convertible
Debt
Differential
Rights
Operational
Synergies


I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 4
*DDT is payable by Indian company @ 16.995%
Investment Vehicle

The choice of investment vehicle is largely based on the regulations and the tax considerations
existing in the country where the target company is situated. The overall guiding principle
would be that the investment vehicle qualifies to claim treaty benefit under the tax treaty
between India and the relevant jurisdiction. The choice of investment vehicle would be
considered at 2 levels i.e. Jurisdiction Level & Indian Level (Country of the target Company)

Jurisdiction level Parameters

1. Ease of formation and administration

2. Ease of Exit

3. Local Regulatory (non-tax considerations)

4. Tax treatment in the country of residence

5. Tax differentiators vis--vis tax treaties with India. This becomes critical due to the fact
that the same income not be taxed twice under two different jurisdictions






I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 5
Indian level Parameters

1. FDI restrictions in India based on the sectoral caps in place

2. Regulatory registrations and administration Taxation and duties

The impact of tax treaties and agreement between various countries and the optimum use of
offshore finance centers and tax havens is critical for structuring a transaction Funding Options

Funding Options

The funding options available for the structuring would vary depending upon the present
structure of the company and the availability of debt. The normal options available would be
Equity, Preference, Convertible Debt and Differential Rights apart from the structured funding
options. These would vary based on

The investor' s preference for dividend or liquidation or both

Prevailing Indian exchange control laws, which do not permit foreign equity investment
beyond a certain level in certain sectors

The investor may wish to get disproportionate voting rights on its investment in return for
the strategic value such investor may bring to the table

Restrictions placed by the Indian corporate and securities laws with respect to equity
shares which may not suit the commercial understanding between the parties.
1. Equity

Most sectors have been opened up for foreign investment and, hence, no approvals from the
government of India are required for issue of fresh shares with respect to these sectors

The tax implications are as under:

a) Dividends

Dividends can be freely repatriated under exchange regulations
Transfer to reserves before declaring dividends
Dividends not taxable in hands of shareholders
The domestic company must pay dividend distribution tax (DDT) at the rate of 16.995%
(15% plus surcharge of 10% and education cess of 3%)

b) Capital

Repatriation of funds not possible, as equity capital cannot be withdrawn during the life-span of
the company, except in the case of a buy-back of shares



I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 6
2. Preference Capital

Preference shares (except fully convertible) are considered as debt and has to be issued in
conformity with ECB guidelines/caps

Tax Implications

Dividends

On fully convertible, can be repatriated but the maximum rate is capped
On any other type needs to confirm to the all- in-cost ceiling prescribed in the ECB
guidelines
Tax Implications same as Equity shares

Capital

No company can issue preference shares that are either non-redeemable, or are
redeemable after 20 years from the date of their issue.

3. Convertible Debt

The policy was made significantly tighter by the Reserve Bank of India (RBI) in 2007 for
preference shares and debentures whereby only fully and mandatorily convertible instruments
are now considered to be FDI. All other preference shares and debentures (and including those
that are optionally convertible) are considered to be debt and hence governed by the guidelines
on ECBs.

Interest

On fully convertible, can be repatriated but the maximum rate is capped
Tax Implications as income on interest ( at par with treaty with jurisdiction)

Principle

Repatriation of funds not possible, as it will be converted into equity & equity capital
cannot be withdrawn during the life-span of the company, except in the case of a buy-
back of shares

4. Differential Rights

Shares with differential voting rights (DVR shares) are like ordinary equity shares but
with differential voting rights. They are listed and traded in the same manner as ordinary
equity shares. However, they mostly trade at a discount as they provide fewer voting
rights compared to ordinary equity shares (sometimes called specific rights). Companies
generally compensate DVR investors with a higher dividend.
Dividend and Capital treatment is same as that of ordinary Equity share


I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 7
Tax treatment in the hands of Indian partner
(Capital Expenditure and Revenue Expenditure)-Important court cases
UNDERSTANDING CAPITAL & REVENUE RECEIPT & EXPENDITURE WITH
LATEST CASE LAWS:
There is always a dispute in respect of capital and revenue receipt and expenditure. Lets
clarify the same with the help of some of the latest judicial decision in this respect.
01. Non Compete Fees: Non-compete fee received by assessee for refraining from manufacturing
and selling time pieces for a period of ten years after the sale of its units while it was continuing
with its other business activities constituted revenue receipt. Refer Tata Coffee Limited, 29 DTR
336.
However, in the case of Tecumseh India (P) Limited v ADD CIT, ITAT Delhi held that Non-
compete fee is capital expenditure.
In the case of BASF India Ltd. vs. Addl. CIT, it was held that Amount received on account of
transfer or assignment of marketing rights in exchange of source of income is a capital receipt.
Amount received as non-compete fee is a capital receipt. Capital gains not taxable where cost of
acquisition not determined.
02. Reimbursement: Payment by way of reimbursement of expenses incurred on behalf of payer is
not income chargeable to tax in the hands of payee. Refer Siemens Aktiongesellschaft, 15 DTR
233.
Similar decision was given in the case of Rajesh Pilot, 175 Taxmann 8, it was held that It was
found that the money received by the agent was spent on the expenditure of jeeps required for
the election campaign of the assessee. The Court held that every receipt is not taxable as income.
It may be receipt, but not necessarily income.
03. Government Incentives: Incentives in the form of excise duty refund and interest subsidy which
has been granted for substantial expansion of unit, only after commencement of production and
not for setting up of new industries or to purchase capital assets, same constitute revenue receipt.
Refer, Shree Balaji Alloys, 33 DTR 67.
However, in the case of Reliance Industries Limited, the Supreme Court held that the assessee
received sales-tax incentive for setting up a new industrial undertaking in Patalganga. The
assessee claimed that the said subsidy was a capital receipt. The Special Bench (DCIT vs.
Reliance Industries Ltd 88 ITD 273) upheld the assessees claim. On appeal by the department
(for a subsequent year), the Bombay High Court held (order enclosed) that as a finding had been
recorded by the Special Bench that the object of the subsidy was to encourage the setting up of
industries in the backward area by generating employment therein, the subsidy was, applying the
purposive test in Ponni Sugars and Chemicals Ltd 306 ITR 392 (SC), a capital receipt and held
that a substantial question of law did not arise. The department filed an appeal to challenge the
judgment of the High Court. HELD allowing the appeal.


I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 8
Similar view was provided in the case of CIT v. Rasoli Ltd, 245 CTR 667, Subsidy received by
assessee from the State Government under a scheme of industrial promotion, which was meant to
provide financial assistance to specified industries for expansion of capacities, modernization
and improving their marketing capabilities, is capital receipt, though the amount of subsidy is
equivalent to 90 percent of the sales-tax paid by the beneficiary.
04. Prior Income before business commencement: Prior to commencement of business interest
earned by parking surplus funds in bank, constitutes a capital receipt and hence is eligible for
being set off against pre-operative expenses. Refer, Indian Oil Panipat Power Consortium Ltd.,
181 Taxmann 249. However, please refer Tuticorin Alkali judgment also.
Similar view was given in the case of CIT vs. Arihant Threads Ltd, 49 DTR 251, where it was
held that Interest on deposit of margin money for opening of letter for credit for import of
machinery at the stage of setting up of industrial unit of the assessee is a capital receipt and the
same is to be set off against preoperative expenses.
Again, similar view was given in the case of CIT vs. Siya Ram Garg (HUF), 49 DTR 126, where
it was held that Interest on deposit of margin money for opening of letter for credit for import of
machinery at the stage of setting up of industrial unit of the assessee is a capital receipt and the
same is to be set off against preoperative expenses.
05. Termination Compensation : Termination of an agency agreement which has no major effect
on profit earning apparatus, the compensation received is taxable as revenue receipt but the part
of the compensation which is attributable to restrictive covenant is capital receipt and not
chargeable to tax. Refer Chemet, 122 TTJ 766.
In the case of S. Zoraster & Co., 31 DTR 10, it was held that Compensation received by assessee
from the other party for termination of the agreement for transfer of property to be treated as
capital receipt and not as revenue receipt.
Further, in the case of CIT v Saurashtra Cement Limited, SC held that Compensation for
sterilization of profit earning source is a Capital receipt.
In the case of Ansal Properties & Industries Ltd. vs. CIT, 238 CTR 126, it was held that
Compensation received from the land owner on termination of development agreement was the
deprivation of potential income and loss of future profits as mentioned in the settlement
agreement and not for divesting the assessee of its earning apparatus, as restrictive covenant in
the said agreement only prohibited the assessee from undertaking a similar project in the vicinity
of the existing project without consent of the land owner for the limited duration of three years,
and therefore, the compensation was a revenue receipt.
Again in the case of Ion Exchange (India) Ltd. vs. ITO, 52 DTR 411, Mumbai ITAT held that
Consideration received for premature termination of the joint venture agreement constituted
revenue receipt.
06. Know How Acquisition : If Know how acquired relates to process of manufacture, then any
payment made for said purpose would have to be considered as a revenue expenditure. Refer CIT
v Munjal Showa Limited.


I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 9
07. Advance : Assessee received advance of Rs. 9 crores from certain foreign buyers, however he
could not export within one year as stipulated by RBI vide its regulation, notification No. FEMA
23/2000-RB dt. 3-5-2000, and assessee periodically withdrew the amount and used for other
business purpose. Assessing Officer treated the said receipt as income and made addition. On
appeal CIT(A) deleted the addition. The Tribunal held that on the relevant year liability to pay
was existing and foreign partys claim was still enforceable under the law. After getting the
approval from RBI the assessee remitted the amount to the buyer through banking channel,
therefore, the order passed by the CIT(A) was upheld. Refer, ITO vs. Eurostar Distilleries (P)
Ltd, 41 SOT 434.
08. Goodwill Compensation: If good will of the business is damaged on account of action of
supplier of goods and later on some compensation is awarded in lieu of that, it will fall in the
same category of loss to the source of income and consequently such a receipt will qualify to be
characterized as a capital receipt. Refer; Inter Gold (India) (P) Ltd. vs. Jt. CIT, 47 DTR 150.
09. Gift from Public in Large : Where the devotees out of natural love and affection and veneration
used in large numbers on the birthdays of the assessee and voluntarily made gifts, it cannot be
said that the amount received by the assessee by way of gift would amount to vocation or
profession since it is not the case of the Department that the devotees were compelled to make
gifts on the occasion of the birthday of the assessee and therefore the same were not taxable as
income in the hands of the assessee. Refer, CIT vs. Gopala Naicker Bangaru, 46 DTR 480.
10. Settlement : Assessee had availed various facilities from Madurai Bank over years, repayment
of which was guaranteed by way of change on properties of assessee. As assessee failed to pay
dues, bank filed a civil suit. Subsequently, out of settlement was reached at an amount of Rs. 160
lakhs. Vide Government resolution dt. 14-12-1994 and 19-7-1995, NSSK was permitted to buy
spares, plant and machinery of assessee. It was to pay, on behalf of assessee a sum of Rs. 160
lakhs to Madhurai Bank towards settlement of amount due. The assessee claimed that as NSSK
directly paid Madurai Bank it should be excluded from the sale consideration as that never
became the income of the assessee as it stood diverted of overriding title and hence, should be
ignored for the purpose of calculating capital gain. The Tribunal held that payment to bank is
only application of income not a charge on income. The payment to bank and sale consideration
of its assets are entirely two distinct transactions having no relat ion with each other except for
the fact that there was a charge by bank on assets. Hence, amount not deductable from sale
consideration. Refer, Shree Changdeo Sugar Mills Ltd. vs. Jt. CIT, 44 SOT 479.
11. Payment Received under degree of Court : In year 2004, the assessee had purchased certain
land. On the eastern side of property, P a public company of developers, had trespassed
assessees property by using a private road to reach their land located the said property. To get
the encroached portion retrieved, the assessee filed civil suit for restraining that companys entry
on assessees land. As per the Court decree resulted in to by way of compromise between parties,
the assessee permitted the use of private road enabling P to reach its property and in turn P
paid certain amount to assessee. The assessee treated the said receipt as capital receipt. The
assessing officer treated the said receipt as rent and taxable as income from house property.
Commissioner (Appeals), reversed the finding of Assessing Officer. The Tribunal held that there
being no relationship of land lord and tenant, between parties, amount received by assessee was
only a capital receipt could not be taxed under the Act being an intangible asset having no cost.
The Tribunal also held that the said receipt cannot be taxed as income from other sources. Refer,
Dy. CIT v. T. Kannan, 48 SOT 374.



I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 10
Income tax - Sec 28(va) - Whether compensation received on termination of Joint Venture
with non-resident is capital receipt - NO, it is revenue receipt: ITAT
By TIOL News Service
MUMBAI, JAN 03, 2011: THE issue before the Tribunal is - Whether compensation received
upon the termination of Joint Venture Company is a capital or a revenue receipt. And the
Tribunal's verdict goes in favor of Revenue.
Facts of the case
The assessee is engaged in the business of manufacturing and selling water treatment chemicals,
equipments etc. The assessee company i.e. Ion Exchange (India) Limited entered into a joint
venture agreement with M/s. W. R. Grace & Company of USA (for short WRG) on 16th
September 1994 and the joint venture was to be known as M/s. Dearborn Ion Exchange (India)
Limited (for short DIEI). In this joint venture Grace was to hold 51% shareholding whereas
assessee was to keep its holdings at 49%. WRG sold its business in June 1996 to M/s BETZ
Laboratory Inc. USA which were highly active competitors and which had affected the business
of joint venture DIEI. Subsequently, WRG terminated the joint venture agreement w.e.f. 31-3-
1997. The assessee company launched certain proceedings against WRG for recovery of
compensation for termination of the joint venture agreement before the International Chamber of
Commerce by way of an arbitration and ultimately the matter was settled between the parties
through a Settlement Agreement dated 31- 3-1998 by which WRG agreed to pay al sum of USD
2.25 millions equivalent to Rs.8,93,22,047/-. This amount was credited to profit & loss account
as revenue receipt and in the statement of income this amount was shown as extraordinary item
of compensation and included in the income returned by the assessee. Later on, a letter dated 19-
2-2002 was submitted to AO through which it was requested to treat this amount of
compensation as capital receipt. Through this letter it was mainly stated that to be an assessable
income the item must fulfill the basic condition that it should fall under one of the heads of
income. It was claimed that an amount received by an assessee as compensation for loss of profit
making apparatus is a capital receipt and, therefore, same is not taxable and for this reliance was
placed on the decision of the Bombay High Court in the case of CIT vs. Khushalbhai Patel &
Sons. The AO held that the compensation received by the assessee is connected with loss of
income or profits by virtue of loss of standing charges and fees and therefore, the receipt would
assume the form of a revenue receipt and not capital receipt and accordingly taxable. The CIT(A)
confirmed the action of the AO.
On further appeal, the ITAT held that,
No separate source or apparatus for earning a separate income was created through the
joint venture. It was a simple case of doing the business in a particular way and the whole
business was carried on even after the termination of the Joint Venture Agreement. The


I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 11
assessee company was engaged in the business of manufacturing and selling of water
treatment equipments and chemicals before entering into the joint venture and continued
to do the same even after termination of the joint venture;
If the receipt of compensation for cancellation of a contract does not affect the trading
structure of business of the assessee nor deprive him of what in substance is his source of
income and termination of contract being a normal understanding, then such
compensation has to be treated as revenue receipt. In this case, the assessee has not been
deprived of his business and, in fact, as observed repeatedly the same business continued
before the joint venture and after the termination of the joint venture
In view of the above discussion, the compensation received by the assessee company has
been rightly treated by the lower authorities as revenue receipt and accordingly confirmed
the order of the CIT[A].
Joint Ventures Abroad
The following requirements will have to be compiled with for setting up joint ventures abroad:

Companies act
FERA section 27 of Foreign exchange regulation act 1973
Approval of Reserve Bank
o For sending representative
o For remittance of cash
Holding securities and shares abroad
Tax concessions under income tax act
Deduction of 50% of royalties, commission etc, received from foreign enterprises

Major Issues
Valuation Problems
Transparency
Conflict Resolution
Ownership and management control
problems
Changes in ownership shares
Marketing and staffing issues
Problems related to multi- nationality
Export rights
Tax issues
Dividend and investment policies
Differences in partner size

There may be other control problems
Product line disputes
Material and component sourcing
Technology utilization
Cultural problem







I n t e r n a t i o n a l J o i n t Ve n t u r e s , Me r g e r s & Ac q u i s i t i o n s
MB I B 0 4 ( U n i t I I I )

Page 12
Benefits of an International Joint venture
Access to new markets and distribution networks
Increased capacity
Sharing of risk with partner
Access to greater resources, including specialized staff and Technology
A joint venture can also be very flexible
Popular with transport, travel and courier companies that operate in different countries
Problems likely to arise if:
The objectives of the venture are not 100% clear and communicated to everyone involve
The partners have different objectives for the joint venture
There is an imbalance in the level of expertise, investment or assets brought into venture
by different partners
Different cultures and management styles results in poor integration and cooperation
The partners dont provide sufficient leadership and support in early stages
A contractual joint venture, such as distribution agreement, can include termination
conditions
The company can give time periods notice to terminate the JV
One company can buy out other

The original agreement should also set out what will happen when the joint venture comes
to an end
How shared intellectual property will be unbundled
How confidential information will continue to be protected
Who will be entitled to any future income arising from the JV activities
Who will be responsible for any continuing liability e.g. debts and guarantees given to
customers
Understanding the cultural background of all countries involved
Negotiating win-win contract
Having comprehensive JV agreements which lays down a road map of duties and
obligations of all the parties involved
Having a workable and efficient dispute resolution mechanism
Involving lawyers from all the jurisdictions early on
Giving scope for international contingencies and environment
Understanding legal and regulatory regime of all the jurisdictions involved
Termination terms and conditions

Some examples

Lee coopers joint venture with Pantaloon Retail (India) to market Lee coopers denim
apparel in India

Fossil in 50:50 joint ventures with Rajesh Exports