Liability of Service Tax of Revenue Sharing Type Unincorporated Joint Venture

CBE&C, by magic, has created a ‘new entity’ out of nowhere in its recent circular dated 13-12-2011, which has given rise to new spate of controversy. Though the issue in CBE&C circular relates only to cinema exhibitors, the view expressed has much wider implications which can affect service tax liability of many UJV (Unincorporated Joint Venture).  The implications of the circular are discussed in this article.

1. Nature of Joint Venture

As per Black’s Law Dictionary (7th edition page 843), Joint Venture is a business undertaking by two or more persons engaged in a single defined project. The necessary elements are – (1) an express or implied agreement (2) a common purpose that the group intends to carry out (3) shared profits and losses and (4) each member’s equal voice in controlling the project – quoted with approval in Faqir Chand Gulati v. Uppal Agencies (2008) 15 STT 296 (SC).

The expression ‘joint venture’ is more frequently used in United States. It connotes a legal entity in the nature of a partnership engaged in the joint undertaking of a particular transaction for mutual benefit or an association of persons or companies jointly undertaking some commercial enterprise wherein all contribute assets and share risks. It requires a community of interest in performance of the subject matter, which may be altered by agreement, to share both in profits and losses. [Black’s Law Dictionary, 6^th Edn, p 839]. According to Words and Phrases, permanent edn, a joint venture is an association of two or more persons to carry out a single enterprise for profit. (p 117 Vol. 23). A joint venture can take the form of a corporation where two or more persons may join together. A joint venture corporation has been defined as a corporation which has joined with other individuals or corporations within the corporate framework in some specific undertaking. - New Horizons Ltd. v. UOI  89 Comp Cas 849 = (1995) 1 SCC 478 = 1995 AIR SCW 275 – quoted with approval in Gammon India v. CC (2011) 269 ELT 289 (SC).

Joint control is essential - If there is no joint control and no share in profit/loss of venture, it is not a joint venture – Faqir Chand Gulati v. Uppal Agencies (2008) 15 STT 296 (SC). In this case, the land owner had agreement with builder termed as ’collaboration agreement’ or ‘joint venture agreement’. However, land owner had absolutely no say in matter of development, construction or sale of flats. It was held that this is not ‘joint venture’. If there is no joint control, it is not a joint venture. [Hence, land owner is ‘consumer’ within the meaning of Consumer Protection Act’].

2.1 Types of Joint Ventures

Accounting Standard AS-27 envisages three types of joint ventures - (a) Jointly controlled operations (b) Jointly controlled assets (c) Jointly controlled entities.

In all these, contractual arrangement and joint control are essential.

Incorporated Joint Venture - In case of ‘jointly controlled entity’, a separate legal entity is constituted (either as company or a partnership firm). This can be termed in Incorporated Joint Venture (IJV). In such case, any service provided by any member of the ‘jointly controlled entity’ to the IJV (or vice versa), should be liable to service tax, since the member of joint venture and the ‘jointly controlled entity’ are two separate legal entities. Similarly, if one member of IJV provides some service to other member of IJV, it should be liable to service tax.

In IVCRL Infrastructures and Projects Ltd. v. CC 2004 (166) ELT 447 (CESTAT), it was held that a joint venture is a form of partnership between two entities with joint and several responsibilities. It is a legal entity in nature of partnership – followed in Techni Bharathi Ltd. v. CC 2006 (198) ELT 33 (CESTAT).  (However, this is not ‘partnership’ as per Partnership Act, since there is no ‘mutual agency’. See discussions below).

Unincorporated Joint Venture - In case of ‘jointly controlled operations’, there is no formation of a separate legal entity. Responsibilities and authorities of each joint venturer should be demarcated. In case of jointly controlled operations, each joint venture partner does his part of work and gets his share of remuneration as agreed (either as share of profit, income or revenue). This can be termed in Unincorporated Joint Venture (UJV). In such case, issue is whether any service provided by any member of the ‘jointly controlled operations’ to the UJV (or vice versa), are liable to service tax. Similarly, whether it can be said that one member of UJV is providing service to other member of UJV when each member is only doing his part of work. Is there any relation of ‘service provider’ and ‘service receiver’ between two members of UJV.

In my view, when one venturer undertakes activities as per the agreement of joint venture, it cannot be said that he is providing any service to another joint venturer. He is doing his part of activity as agreed by joint venture. He is doing the activity for himself.  In case of jointly controlled operations, there is no third party to whom the member of joint venture is providing any service or is receiving service.

 However, this view has not been accepted by department as clarified in circular dated 13-12-2011.

2. Recent CBE&C circular and its background

CBE&C vide circular No. 148/17/2011-ST dated 13-12-2011 has clarified as follows -

In some cases, the parties conduct business together on revenue sharing basis. Here there is mutuality of interest and they share common risk/profit together. The arrangement is not on principal to principal basis.

Such arrangement is in nature of joint venture. Such joint venture is also recognised as a legal and juristic entity in nature of a partnership. It is a new entity distinct from its constituents. Such ‘new entity’ acquires character of a ‘person’ and the transaction between the ‘new entity’ and the constituents of the new entity (i.e. persons who have come together on revenue sharing basis) will be a taxable service.

In case of Joint venture type arrangement i.e. revenue sharing arrangement, Service provided by each person i.e. ‘new entity’, and constituent of such ‘new entity’ is liable to service tax under appropriate head (like renting of immovable property or Business Support Service or copyright service as applicable)

Where relations between the parties are on principal to principal basis, the service tax would be leviable on either of the parties based on nature of transaction.

Circular applies to all such revenue sharing arrangements - Though the circular is issued in relation to cinema exhibition, para 12 of the circular dated 13-12-2011 states as follows - ‘The arrangements mentioned in this Circular will apply mutatis mutandis to similar situations across all the services taxable under the Finance Act’.

2.1 Background of the circular

CBE&C, vide circular No. 109/3/2009-ST dated 23-2-2009 had clarified as follows - Screening of movie by theatre owner is independent activity. It is not a support service to distributor of films. Service of theatre owner will be taxable only when he gives theatre on lease to distributor on fixed rent basis. In that case, the service will be taxable under renting of immovable property service. If the arrangement between theatre owner and distributor is on revenue sharing basis or on basis of fixed guaranteed amount to theatre owner by distributor, the relation is principal to principal and such service will not be a taxable service.

Now this circular has been practically withdrawn vide circular dated 13-12-2011, where it is stated as follows - ‘It is understood that the Circular dated 23-2-2009 has been misinterpreted to exclude all 'revenue sharing' arrangements from the levy of service tax. Remuneration or payment arrangements on basis of fixed or revenue sharing or profit sharing or hybrid versions of these may exist. However, the nature of transaction determines the leviability of service tax. Each case may be looked into on its merits and decision be taken on case to case basis (para 11 of the circular dated 13-12-2011) (practically, it means ‘issue show cause notice, confirm demands and start recovery proceedings).

As stated above, CBE&C has now expressed a view that such revenue sharing arrangement creates a ‘new entity’ (though unincorporated and unnamed).

My comments - In case of ‘UJV’, there is no third legal entity. Thus, the ‘new entity’ as envisaged by CBE&C has no name, no legal existence, no PAN number and no document evidencing its formation, creation or registration. How such a non-existent ‘new entity’ can receive service or provide serviced? It seems that by magic, CBE&C has created a ‘new entity’ from nowhere.

2.2 Tribunal decision that activity done by each member of Joint Venture is not ‘service’ to other member

In Mundra Port and Special Economic Zone Ltd. v. CCE (2011) 33 STT 364 = 15 taxmann.com 33 (CESTAT), assessee had constructed rail line between port and railhead under private-public sector collaboration on revenue sharing basis. It was held that this is not ‘Business Support Service’. - - In the same case, the assessee, who was licensee of Government of Gujarat for development of port had appointed sub-licensee to maintain container terminal, for which the sub-licensee was paying royalty and profit sharing. It was held that this is also not business support service.

Though the decision is in respect of ‘Business Support Service’, the principle should apply to all revenue sharing arrangements.

In Nyco SA v. CST (2009) 20 STT 113 (CESTAT), a joint venture company was formed to share expertise and know-how of both the parties. Fruits of joint venture were shared by both the parties. It was held that sharing of knowledge cannot be termed as providing consulting engineering service as expertise acquired is used for own benefit along with others.

In CCE v. Sundaram Finance (2007) 9 STT 100 (CESTAT), it was observed that work done by a joint venture partner is in the nature of ‘in-house services’ rendered by him as partner of the JV company.

3. Is UJV a Partnership’?

As per section 4 of Indian Partnership Act, 1932, 'partnership' is the relation between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all.

Essential of partnership are - (a) It is relation between two or more persons (b) There should be agreement (c) Agreement should be to share profits of business (d) Business can be carried by all or any of them acting for all.

However, real test of partnership is ‘mutual agency’.

As per section 18 of Partnership Act, a partner is agent of firm. Section 19 states that act of partner in usual course of business binds the firm. Partner is liable for acts of firm (section 25). Firm is liable even for wrongful acts of the partner (section 26). Thus, any partner can bind the firm. Since firm is responsible for acts of a partner, acts of one partner binds all other partners. Any partner can bind firm (and hence automatically other partners). Thus, they are ‘mutual agents’. The real test of ‘partnership firm’ is ‘mutual agency’, i.e. whether a partner can bind the firm (and hence indirectly other partners) by his act and whether other partners can bind him by their acts.

In case of Unincorporated Joint Venture (UJV), the members are not ‘mutual agents’ and hence the UJV is not

4. Is the UJV an ‘Association of Persons’ and be treated as a ‘person’

Service tax is payable when service is provided by a ‘person’ to another ‘person’ [section 68(1) of Finance Act, 1994]. Various definitions of ‘service’ under section 65(105) of Finance Act, 1994 also provide that a service is taxable when provide by a ‘person’ to another ‘person’.

The issue is whether the UJV is a ‘person’. The term ‘person’ is not defined under Finance Act, 1994.  As per section 3 (42) of the General Clauses Act, ‘person’ shall include any company or association or body of individuals, whether incorporated or not.

The members of UJV are mostly companies or firms. The company or firm is ‘persons’ but not ‘individuals’. The UJV can be said to be ‘Association of Persons’. However, it is not ‘association or body of individuals’. Thus, it cannot be termed as ‘person’ under General Clauses Act.

It is true that as per Income Tax Act, ‘association of persons’ has been included in the definition of ‘person’. Even in Income Tax, these words were not there in earlier Act. Further, it is well settled that Definitions/expressions in other Acts cannot be used to interpret words/expressions in another Act, unless both the Acts are in pari materia. - Hari Khemu Gawali v. Dy. Commissioner of Police, Bombay - AIR 1956 SC 559 * Board of Muslim Wakfs, Rajasthan v. Radhe Kishan - AIR 1979 SC 289  = (1979) 2 SCC 468 * S Mohan Lal v. R Kondiah - AIR 1979 SC 1132 * CIT v. Benoy Kumar Sahas Roy AIR 1957 SC 768 * Maheshwari Fish Seed Farm v. Tamil Nadu Electricity Board 2004 AIR SCW 2442 = (2004) 4 SCC 705 * Sudesh Kumar v. State of Uttarakhand AIR 2008 SC 1120.

Central Excise Act can be said to be ‘pari materia’ with service tax law, but even that Act does not define ‘person’.

Income tax liability of JV as AOP – In Geoconsult ZT GMBH In re (2008) 172 Taxman 396 (AAR), it has been held that an unincorporated Joint Venture is ‘Association of Persons’ for purpose of income tax. Essentials of AOP are –(i) two or more persons (ii) Voluntary combinations and (iii) A common purpose or common action with object to produce profits or gains.

5. The UJV can provide service to its members

An explanation inserted after section 65(121) of Finance Act, 1994 (w.e.f. 1-5-2006), states that taxable service includes any taxable service provided or to be provided by any unincorporated association or body of persons to a member thereof, for cash, deferred payment or any other valuable consideration.

Thus, an unincorporated association providing service to its members can also be said to be ‘a person’ for purpose of service tax. However, this is only when such body provides service to its members and not vice versa.  The explanation is also not applicable when such unincorporated association provides service to third persons and not to its members.

Further, such unincorporated association should have some identity of its own (e.g. club or association with some name).

Hence, the explanation cannot be used to say when one member of the unidentified and unnamed IJV does some work which can be said to be service to other member.

6 Suggested arrangement in Unincorporated Joint venture

The Unincorporated form of joint venture (UJV), i.e. ‘jointly controlled operations’ is suitable for forming joint venture between two parties (e.g. builder and landowner, hospital and company providing administrative services, film distributor and cinema exhibitor etc.). Responsibilities and authorities of each joint venturer should be demarcated.

Remuneration of each partner to joint venture - Mode of remuneration of each partner in joint venture will be specified in joint venture agreement. The remuneration can be on cost plus basis or profit basis or a combination of two. Sharing of income with some minimum remuneration (e.g. the partner will get 1% of income with minimum ` 1,00,000 per month) can be provided.

Committee for joint control of operations – Each joint venture partner will do his part of the work. A committee consisting of representatives of all joint venture partners should be formed. The joint venture agreement should provide for appointment of Chairman of committee, composition of committee, quorum for meeting, frequency of meeting, Secretary of committee etc. Proper minutes of meetings should be maintained.

Distribution of income through escrow account – It is advisable that total income of joint venture should be deposited in an escrow account, which can then be distributed among joint venture partners as per agreed formula. The escrow account should be jointly operated. Escrow account is advisable since a separate legal entity is not being formed.

Liability of each partner to JV – Since each partner is doing his part of the work, the other partner will not be responsible for acts of other joint venture partner. This should be clarified in the Joint Venture Agreement.

7. Conclusion

In my view, an Unincorporated Joint Venture (UJV) having no name or identity cannot be termed a ‘new entity’. It cannot be said that one member of UJV is providing service to other member or to the UJV itself. However, in view of the departmental circular dated 13-12-2011, show cause notices and demands and litigation is inevitable.