Indian Court taxes offshore supply alleging artificial splitting up


published on 21 June 2023 | Reading time approx. 9 minutes

The Chennai Bench of the Income Tax Appellate Tribunal (ITAT) – a lower Tax Court – has held that income of a German company (Taxpayer) from supply of equipment, supervision and installation are inextricably linked and a part of the same turnkey project and therefore, taxable in India. The ITAT placed reliance on an earlier decision in the Taxpayer’s own case that had upheld the allegation of Indian tax authorities that the three parts of the turnkey contract, viz. (i) offshore supply, (ii) supervision charges and (iii) installation and commissioning of project were indivisible; but had been artificially split. Consequently, it was held to be a composite contract and supplies were held to be taxable in India.  



Turnkey contracts, involving supplies and services (both offshore and onsite), in general, have been under revenue scanner in India and tax positions adopted by taxpayers are constantly litigated by the Indian tax authorities. This newsflash summarizes the above decision[1] and key takeaways for foreign companies negoti­ating or proposing to enter into similar contract structures with Indian companies.


In the above mentioned decision, the facts involved are discussed below.
The Taxpayer undertakes turnkey projects for Indian automobiles manufacturers. The contract with one of its major Indian Customers, was under scrutiny by the Indian tax authorities. The Taxpayer also had a wholly owned subsidiary (WOS) in India, which assisted it in installation and other activities.
Taxpayer had agreed for a Turnkey Contract with its Customer for setting up a paint shop. The project involved supply of paint shop material/equipment and rendering of services starting from engineering till erection, in­stallation and commissioning of the project.
The entire Contract was spilt into three parts and separate purchase orders (PO) were issued by the Customer as follows:

This was the second round of litigation before ITAT for the same year for the Taxpayer. In the first round of litigation, the ITAT had affirmed the findings of tax authorities on merits regarding composite contract, exis­tence of PE, taxation of all elements of contracts. The matter was remanded back to the tax officer on compu­tational aspects for determining taxable income of PE, after considering submissions of the Taxpayer. In the second round of litigation before the ITAT, it was observed that several details sought by tax authorities were not provided by the Taxpayer and the billing data was also not reconciling. Hence, one more opportunity has been provided to the Taxpayer on computational aspects to provide complete financial details in order to determine income attributable to PE.
Various facets of the issue regarding Taxation of Turnkey contracts discussed in these cases of Taxpayer should provide useful guidance to other foreign entities having turnkey projects from Indian customers. We have discussed below some key aspects that were considered against the Taxpayer to uphold taxation of all streams of the Turnkey contract in the hands of Taxpayer:

Entire project was considered to be a composite contract, basis:
  • At RFQ (Request for Quote) stage what was considered as a single composite turnkey contract, was later split into multiple parts (with three separate purchase orders from Customer) at the insistence of Taxpayer.
  • All activities from engineering stage to supply erection, installation, commissioning and completion were all inextricably and organically linked.
Income from contract accrued to the Taxpayer in India and source of income was in India, basis:
  • Risks and responsibilities of entire contract vested with Taxpayer.
  • The liability of Taxpayer was to cease to exist on successful execution of the entire project (being a turnkey project).
  • Place where plant was to be erected was also taken into account while determining the place of accrual of income.
  • The imported material was under custody of Taxpayer at a storage area maintained on site
  • Taxpayer had a PE in India in respect of offshore supplies by virtue of presence of site office/storage area.
  • Passing of risk associated with project was to happen in two stages viz., passing of risk over equipment and passing of risk over completed project to the Customer. These were dependent on commissioning of the project, starting of pilot production and pre-acceptance by the Customer. The Taxpayer had to give final proof of performance.
  • While the installation activities were undertaken by Indian WOS, the personnel on the payroll of the Taxpayer were stationed in India at Customer’s premises to oversee the operations, which established the direct involvement of Taxpayer in installation and commissioning activities.
It can be observed that there have been various factual aspects regarding overall contract responsibility, passing on risks in equipment/project, presence of Taxpayer’s employees, storage area in India have been looked at cumulatively to hold that all elements of contracts were taxable in the hands of Taxpayer. However, in case of Turnkey contracts, this kind of situation may often arise where related or unrelated parties come together and execute the contract. In case of unrelated parties, it may be relatively less challenging to establish separation of roles and responsibilities, risk elements among parties involved, which may support tax treatment adopted by respective taxpayers for their respective portions. However, same may not be the case, when related parties are involved. Parent entity (or main executing entity) may be considered to bear overall risks and responsibilities, even if Indian entity is independently capable of executing its share of project, which may trigger litigation.
Taxation of Turnkey contracts has become a complex topic with multiple factors being considered in different judgments for determining taxability and it is not in all cases that all such factors would be one way or other way. It involves forming a judgment basis interpretation of several aspects in a wholistic manner, when some aspects may be suggesting non taxation, whereas some may be going other way.
In the context of factors noted above that have gone against the Taxpayer, we have touched upon key takeaways from some other decisions as below:

​Critical factors relied in decision against Taxpayer
​Key takeaways from some other decisions in respect of factors relied in present decisions against Taxpayer
​Emphasised on below to tax offshore supplies:
  • The contract is of a composite nature
  • Taxpayer was responsible for entire contract
  • Risk in equipment passed to Customer after successful commissioning
  • Imported material under custody of Taxpayer at a storage area maintained on site

​Mere composite nature of contract does not lead to taxation of offshore supplies and supply has to be segregated from the installation. offshore supplies are not taxable in India, if the title passes outside India and payments received in foreign exchange and PE has no role to play in completion of supplies.[2]
In different decisions, following factors were not considered sufficient to bring offshore supplies to the tax net:
  • Overall responsibility of the foreign vendor/joint and several responsibility of foreign and Indian parties involved
  • Responsibility of foreign vendor for quality and satisfactory performance of the equipment
  • Foreign Company not relieved of the responsibility for loss or damage to the goods until the final take over and acceptance of the goods
  • Performance guarantee tests to be performed by the foreign vendor, contractual obligation for due performance of the entire Contract
  • Cross fall breach clause, unconditional corporate guarantee for overall contract
  • Onsite custody of goods with the foreign vendor
​Reliance placed on observations of Madras High Court[3] to tax offshore supplies​One of the critical aspects relied on by Madras High Court was that the price of the services contract was loaded on to supply contract. However, there is not much elaboration in the case of Taxpayer on how this point in Ansaldo case is satisfied to uphold taxation of the offshore supplies.
Some subsequent decisions have distinguished the decision of Ansaldo on above referred point not being satisfied.
​Custody of imported material and presence of employees of Taxpayer onsite were the key factors, basis which Taxpayer’s permanent establishment (PE) was upheld.
Tax officer applied 7.33 % Profit mark-up to decide taxable income from Offshore Supplies
​Supreme Court[4] has held one of the principal tests to determine fixed place PE as whether such place is at the disposal of the enterprise. It also held that merely giving access to such a place to the enterprise for the purposes of the project would not suffice but there has to be right to use the said place and control thereupon.
These supporting arguments have not been discussed in the decision.
Further, given the nature of activities considered to constitute a site office/storage PE, even if PE attribution is upheld, jurispru­dence in the context of transfer pricing should be applied to determine profit attribution out of offshore supplies.
​Tax officer applied 7.33 % Profit mark-up to decide taxable income from Installation and Commissioning​There has been no specific discussion around giving a deduction for income already offered to tax by Indian WOS[5]. If this is not granted, there could be double taxation*

* Hopefully, these aspects are taken into account by tax authorities; otherwise, one more round of litigation due to any sort of double taxation cannot be ruled out.
From the above table, it can be seen that the factors considered for taxation of Offshore supplies in the Taxpayer’s case are not static and they have been considered differently in other taxpayer cases. These are very fact specific aspects. Hence, in addition to appropriate coverage of contracts for turnkey projects, some other critical factors such as proper maintenance of records, establishing the factual aspects properly, cor­rectness of information being submitted can support the case and various positive rulings may not help in isolation.

Safeguards to be kept in mind while negotiating turnkey projects

Some of the critical factors that can be kept in mind, while negotiating the turnkey project contracts, have been briefly captured below:
  • Proper segregation of offshore and onsite scope to be undertaken by foreign and Indian entity
  • Clear demarcation of scope between supply and service portions of the contract
  • Identification of roles and responsibilities of contracting parties
  • Linking the contractual liability and performance guarantee to respective scope of each party
  • Reflection of understanding of the parties in the contractual documents in a clear and unambiguous manner
  • Indian entity’s competency and capabilities to take up the assigned work independently without significant dependence on or intervention of foreign entity
  • Transfer of title in equipment/goods outside India
  • Completion of tasks under the offshore supplies contracts outside India
  • Reasonable allocation of contract revenues between supply and service as well as offshore and onsite portion (this involves decision making about entrepreneurial approach vis-à-vis service provider approach for allocation of revenues for onsite activities)
The above provides a quick overview of some key factors to be kept in mind and is not exhaustive, as there are various operational aspects on billing, day to day operations, logistics, record keeping, compliances front that also need to be segregated properly. This does not substitute the need for a thorough analysis of proposed arrangements, careful drafting of contract clauses and maintenance of appropriate documentation with ade­quate back-ups. It would also be interesting to see if the Taxpayer in the case under consideration gets opportunity to take up some of these aspects before the higher appellate forums and how the courts decide on the same.
It needs to be noted that factual aspects also play a very significant role in these kind of situations and obser­vations in other judicial precedents cannot be blanketly applied without correlating factual similarity. There are observations by the ITAT that Taxpayer was also not able to furnish required details to the satisfac­tion of the tax authorities, such as reconciliation of invoices with payments, separate accounting for Indian activities (alleged permanent establishment), etc. Thus, there is a tough task for the Taxpayer to put forward proper factual data to support its case basis various observations made by the ITAT. The issue regarding foreign and Indian parties executing the project are, at times, considered to be forming association of persons (AOP) by tax office. However, the said issue has not surfaced in this case.


Taxation of offshore supplies in Turnkey contracts is a complex and litigation prone issue in India. In most contract structures, responsibility for offshore supply is retained with foreign companies, whereas installation responsibilities are awarded/assigned to their Indian subsidiaries at the behest of the foreign company or otherwise.
There has been a mixed bag of decisions on the issue of composite contracts, some are favourable, including that of the Indian Supreme Court in the celebrated case of Ishikawajima Harima Heavy Industries. However, this Chennai ITAT decision lays down certain distinct argumentation that could be used by Indian tax author­ities to allege constitution of PE on account of storage of equipment at site etc. As noted above, some of the factors considered in this Chennai ITAT decision that have been considered differently in some other decisions. As such, it would be interesting to see, how these aspects get dealt with at the higher appellate forums. Further, the Taxpayer would also need to defend PE attribution and double taxation issue touched upon above in remand back proceedings.

Taxpayers, negotiating/proposing to enter into similar contracts with Indian customers would need to take cognizance of this decision and evaluate its impact on their proposed contract structures.

[1] TS-5398-ITAT-2023(CHENNAI)-O (including, references from the earlier decision for same Taxpayer)
[2] Ishikawajima-Harima Heavy Industries Ltd. – Supreme Court – 288 ITR 408 (2007); LG Cable – Delhi High Court – 197 taxman 100 (2011); DIT vs. Nokia Networks OY – Delhi High Court – 358 ITR 259 (2012)
[3] Ansaldo Energia SPA – Madras High Court - 310 ITR 237 (2009)
[4] Formula One World Championship – Supreme Court – 394 ITR 80 (2017)
[5] Daikin Industries Ltd – Delhi ITAT – 94 299 (2018)
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