Income tax holiday: Eligibility for infra developers demystified

Infrastructure developers are eligible for a tax holiday for 10 years, and the government has permitted a looser interpretation for the benefit of infrastructure. Vishal Shah and Bijal Desai refer to relevant court and tribunal cases and explain the more nebulous of the tax holiday eligibility clauses.

Section 80-IA of the Income-tax Act, 1961, provides a 10-year tax holiday for infrastructure projects. The provisions in this section have evo­lved over the last two decades in line with the changing dynamics of Public-Private Partnerships (PPPs) in the infrastructure sector. Also, the authorities have been vigilant to avoid misuse leading to amendments thereof.

On the flip side, the provisions have led to tax dis­putes and a considerable debate on the scope and eligi­bility of the holiday. In most cases, however, the Courts and Tribunal have taken a liberal interpretation keeping in mind the larger legislative intent behind a tax ince­ptive provision.

This article focuses on some recent litigation updates from the Income Tax Appellate Tribunal on the eligi­bility to tax holiday under Section 80-IA for:

1. Pure developer of infrastructure facility
2. Incidental receipts (way-side amenities, adver­tis­e­ment receipts, etc.)
3. Joint Ventures and SPVs

Infrastructure developer

Whether eligible for tax holiday: PPP model is curr­ently prominent in almost all the infrastructure sectors, and especially so in roads, ports, airports and some urban infrastructure. While Build, Operate and Transfer (BOT) and Build, Own, Operate and Transfer (BOOT) are the most common models in PPP projects, slightly different variants of these are Build and Transfer (BT) and Build, Operate, Lease and Transfer (BOLT).

A company that is engaged in developing, operating and maintaining an infrastructure facility is eligible for the tax holiday. However, there are doubts as to whe­ther a pure developer, who is only involved in the activity of developing an infrastructure facility, would be so eligible. This would typically be the case of BT and BOLT pro­jects where the operation and maintenance (O&M) is not always carried out by the developer.

Recently, the Pune Tribunal, in case of Laxmi Civil Engineering Pvt Ltd, held that mere development of an infrastructure facility is an eligible activity for claiming tax holiday under Section 80-IA. In arriving at its con­clusion, the Pune Tribunal has followed the Bombay High Court's decision in ABG Heavy Engineering Ltd (322 ITR 323), although ABG Heavy was not the case of a pure developer. In 2004, the Gujarat Tribunal also took a view that was favourable to the taxpayer in the case of Patel Engineering Ltd (94 ITD 411).

The provisions: Now, let us look at the relevant pro­visions of Section 80-IA in this context:

• Section 80-IA(4) allows any person carrying on the business of developing, or operating and maintaining, or developing, operating and maintaining an infra­structure facility to claim the tax holiday.  
• Section 80-IA(2) provides that deduction can be claimed only once the taxpayer develops and begins to operate the new infrastructure facility.  
• Explanation to Section 80-IA disqualifies a contra­ctor executing a works contract from being eligible for tax holiday.

Originally, Section 80-IA was intended to cover only entities carrying out developing, operating and maintaining infrastructure facility. Keeping in mind the nature of PPP models in India and the intent to grant them incentives, the CBDT had on a few occa­sions, cla­rified that a pure developer should also be eli­gible, which eventually culminated into an amendment of Section 80-IA itself in 2001, to that clear effect. However, sub­sequent thereto, ostensibly to avoid misuse, an Explanation was introduced in Section 80-IA to cla­rify that a works contractor would not be eligible to the benefits thereof.

Why works contractors are excluded: This exclu­sion needs clarity, particularly considering that a mere dev­eloper would typically not be the owner of the faci­lity and therefore would always be appointed as the con­tra­ctor by the eventual owner.

Now, certainly the Explanation cannot be read to do away with the eligibility of the developer, otherwise the Parliament would have simply reversed the 2001 amendment. Thus, certainly the Explanation should be read to deny the tax holiday only to a works contractor as distinct from a developer (who, in some ways, is also a contractor).

This is clear from the expressed intention of the Parliament while introducing the Explanation in 2007. The Explanatory Memorandum to Finance Act 2007 clearly states that the purpose of the tax benefit has all along been to encourage investment in development of infrastructure sector and not for the persons who merely execute the civil construction work. It categorically sta­tes that the incentive is intended to benefit developers who undertake entrepreneurial and investment risk and not contractors who only undertake business risk.

Without a doubt, both developer and contractor undertake huge risks, deployment of technical personnel, plant and machinery, technical expertise, know-how and financial resources. Distinction between the two would be the key to determine the eligibility for tax holiday.

Typically, this difference can be brought out based on the following parameters:

• Capital investment: Whether the investment is inte­nded for the project as a whole or merely with respect to construction activity.
• Risks undertaken: Entrepreneurial risk associated to the project versus risk limited to the services pro­vided or work done.
• Responsibility: Designing and execution versus exe­cution based on instructions.
• Performance guarantees: Extended to entire project (including issues arising due to external factors) ver­sus covering construction work done alone (limited to work done by the contractor)

In practice, however, it is not so easy to clearly com­partmentalise the developer and the contractor. This is because in a large number of contracts, the developer / contractor undertakes a large number of risks, which could be more than the risks in a works contract but less than risks undertaken by a developer in, say, a BT contract. Therefore, the interpretation should be on a case-to-case basis keeping in mind the initial Request for Proposal (RFP) floated by the government.

Incidental receipts

Roadside facilities and toll receipts: Provision of way­side amenities such as toilets, service stations, phone booths, parking facilities etc are common in road projects these days under PPP. Therefore, it is now quite cus­to­mary to have clauses in the concession agreements that mandate the developer to build such amenities. The que­stion in our context is whether the revenue aris­ing from such facilitation would be eligible for the tax holiday.

In a recent decision in the case of L&T Transportation Infrastructure Ltd, the Chennai Tribunal held that income arising from such wayside amenities would not be eligible for tax holiday purposes. In holding so, the Tribunal observed that roadside amenities are not included within the meaning of “infrastructure facility” for the purposes of the tax holiday provisions. Although the concession agreement provided for the wayside amenities as a part of the road project, the Tribunal held that income from such amenities are inci­dental to or facilitate the business of developing and mai­ntaining roads, but are not eligible to be forming a part of the road itself.

Section 80-IA tax holiday is available to the extent of profits and gains derived from the eligible business. A host of judicial decisions including Supreme Court's rul­ings have interpreted the phrase 'derived from an ind­ustrial undertaking' in the context of other provisions (eg, 80-HH, 80-I, erstwhile 80-IA etc.). The language in the existing Section 80-IA is slightly different and uses the term 'business' instead of 'undertaking', and therefore could have a larger purview. The distinction has been recognised by the Delhi High Court, in case of Eltek SGS (P) Ltd. (300 ITR 6) and held that Section 80-IB (containing language similar to Section 80-IA) had a larger ambit. This has been also dealt with in a couple of Tribunal decisions which have taken a similar view hold­ing that as long as the income emanates from the bus­iness of the industrial undertaking, it should qualify for the tax holiday.

There is reason to argue that wayside amenities, whi­ch are integral to the road facility and without which the facility is really incomplete, should be treated as part of the road. For instance, a toilet maintained on a long road, operation and maintenance of street lights, etc, should form an integral part of road development and should be encouraged, and therefore treated as inextri­cably linked thereto. Receipts from such facilities have a close and direct linkage to the business of the under­taking, and should be eligible for the tax holiday.

The above infrastructural facilities can be distingui­shed from purely incidental facilities such as advertise­ment hoardings, food malls, stores, etc. Yet, given the broader language of Section 80-IA, it could arguably be determined on a case-to-case basis whether such other incidental receipts should be eligible for tax holiday.

Joint Ventures and SPVs

Frequently, investors form a consortium to meet the technical and financial criteria or to leverage each other's areas of expertise. In most cases, a separate com­pany is incorporated, which serves as a Special Purpose Vehicle (SPV) to sign the concession agreement and execute the project. Especially in BOT road projects, the National Highways Authority of India (NHAI) insists on the for­mation of a separate company for project execution.

In some cases, however, an unincorporated joint ven­ture (JV) undertakes the project and bids for it, but the share of work and revenue is pre-determined by the JV partners. The JV remains as a pass-through for bidding and invoicing purposes. In such a case, an issue arises from who would be eligible for the tax holiday-the JV or individual partners.

In dealing with such a case the Tribunal, in a recent case of Transstory (India) Ltd, has held that Section 80-IA extends the benefits to a consortium of companies as well and hence, the JV partners who are actually exe­cuting the contract would be eligible for tax holiday.

Generally, in a PPP project, the government auth­ority insists on fulfilling prescribed financial and tech­nical criteria by the bidder, wherein liability under the concession agreement is joint and several. A consortium which leverages on the joint eligibility and liability of its JV partners is awarded the project. Although the JV partners may define their specific roles, the responsibility would still remain collective.

It is also relevant to note that Section 80-IA reco­gnises such a consortium (which could be taxed as Association of Persons) as eligible for tax holiday if it is engaged in the eligible business. One of the con­ditions to claim tax holiday is having an agreement with the government, which technically the consortium would have signed and not the individual JV partners. Therefore, in a PPP model, the eligibility of the JV partner as to the tax holiday would have to be determined keeping in mind the exact dynamics of the concession agreement as to the individual roles, obligations, lia­bilities, etc.

INTERPRETATION, THE KEY

We hope the courts and tribunals continue to back the legislative intent to allow the benefits of the tax holiday provisions to the extent reasonable and not encourage misuse, while disposing the above additional issues. As we do not get clarity from the courts or trib­unals on some of the aspects discussed above, there are several issues, for instance:

• Eligibility of incomes arising in pre-construction and during the construction period (common in four- to-six-laning roads)
• Setting off brought-forward losses from earlier years  
• Eligibility in cases of restructuring of existing business or expansion of existing business

There would be considerable addition to the issues if the Direct Taxes Code Bill 2010 is enacted from April 2012 as scheduled. The investment-linked tax inc­entive scheme may have its own set of issues to be addressed.

Shah is Executive Director and Desai is Senior Manager, Tax & Regulatory Services, PwC India.