Using AOP to Mitigate AOP Risk: Sections 167B, 86 & 115BAC

While structuring commercial arrangements, an invariable concern is a potential allegation of an Association of Persons (AOP) formation amongst the parties. This arises from ambiguous criteria for AOP formation, coupled with the draconian Maximum Marginal Rate (MMR) based taxation under section 167B.

As per section 167B:

► If members' share are indeterminate/unknown: Entire income of AOP is taxed at MMR. If any of the members of the AOP is subject to tax at a rate > MMR, entire income of AOP is taxed at such higher rate.

► If members' share are determinate: Entire income of the AOP is still taxed at MMR, unless none of the members’ income exceeds basic exemption limit (in such case, slab rates apply). Further, if any member is subject to a tax rate > MMR, only corresponding portion of AOP’s income is taxable at such higher rate.

For determinate AOP, members’ share are specifically exempt in their hands u/s 86. For indeterminate AOP, it is a matter of debate whether members' shares would again be taxable in their hands.

The real pain point is when a post-facto allegation of AOP formation is made, after individual parties have already paid respective taxes. Such alleged AOP, by its very nature, is usually indeterminate.

Thus, for cases where the AOP formation risk is imminent, it may be prudent to catch the bull by its horn, i.e., suo motu constitute a "determinate AOP".

Why so?

Section 115BAC(1A), new regime, changes the game. It provides for slab-based tax rates for AOPs as well, with highest slab rate being 30% for income>Rs. 24 lakhs. Since 115BAC starts with a 𝘯𝘰𝘯-𝘰𝘣𝘴𝘵𝘢𝘯𝘵𝘦 𝘤𝘭𝘢𝘶𝘴𝘦, it would override section 167B and hence, give relief from MMR taxation.

Moreover, although being a non-obstante provision, 115BAC(1A) is still “𝘴𝘶𝘣𝘫𝘦𝘤𝘵 𝘵𝘰 𝘵𝘩𝘦 𝘱𝘳𝘰𝘷𝘪𝘴𝘪𝘰𝘯𝘴 𝘰𝘧” Chapter XII (sections 110-115BBJ) and therefore, the AOP would also be entitled to reduced rates of taxation on capital gains etc.

Notably, 115BAC(1A) is applicable by default (unless opted out) and applies irrespective of whether the AOP is determinate or indeterminate, resident or non-resident.

115BAC(1) may especially be beneficial for a determinate AOP formed by foreign companies, since such AOP would be taxed at reduced slab rates, instead of 35% tax rate applicable to foreign companies. Further, concessional tax rates under Chapter XII and exemption in hands of individual members of AOP u/s 86 continue to apply. However, there may be practical challenges in claiming DTAA benefits or FTC in residence country in some cases.

P.s.: The new Income-tax Act 2025 also supports the overriding effect of new regime over MMR taxation for AOPs, in fact, with a much greater force.

#Incometax #AOP #MMR