24 December 2014

Engineering, Procurement and Construction (EPC) contracts in India

by Ashish Karundia

The economic growth that India witnessed in last two decades has attracted Multinational Enterprises (‘MNEs’) to increase their business presence manifold in India. Many MNEs have won projects involving Engineering, Procurement and Construction (‘EPC’) to be undertaken on turnkey basis. An EPC contract generally involves supply of goods and services, both offshore and onshore. Such contracts may, either be a composite contract i.e. without any breakup of consideration towards goods and services, or on the other hand provide split up of the consideration. The present article aims at highlighting income tax issues that generally arise in relation to such projects.

India follows a blend of residence based and source based taxation.  The treaty framework restricts taxability of MNEs with respect to profits from their unincorporated Indian ventures only to those cases where a Permanent Establishment is created in India or where the income is in the nature of 'fees for technical services'.


Existence of Permanent Establishment ('PE')

Presence of PE can attract tax on the income attributable to the PE at the rate of 40% as against regular corporate tax rate of 30%. Generally the MNEs maintain project office in India in order to efficiently execute the EPC contract. Indian courts have in some cases held a permanent establishment of a foreign enterprise to have resulted because of the project office in India observing that the activities of installation etc were routed through such office[see end note 1].

Generally time threshold of 6 months is required to invoke Installation / Supervisory PE and time threshold for each project is taken individually. Unless properly structured the tax authorities may find that multiple projects are interconnected and apply an aggregate approach for determining whether PE threshold is met. Many Indian treaties have specific clauses for installation and supervisory PE. Depending on the treaty language and facts of a particular case, mere performance of supervision without undertaking installation, construction, etc., can in some cases create a PE.

Some of the Indian treaties recognize furnishing of services (beyond a specific threshold) also as a PE creating activity.  The tax authorities tend to invoke Service PE clause where they are not able to justify existence of Installation / Supervisory PE. They allege that the visit of technical personnel for rendering onshore services in respect of the EPC contract gives rise to Service PE. The exception is where the services rendered constitute ‘technical services’ (infra) which itself may be taxable in India as source country both under its domestic law and treaty.


Commencement of PE

The point of time at which the PE is said to have been set-up is also an aspect that requires due attention. In certain cases, attempt has been made by the tax authorities to justify that PE comes into existence from the time when first activity was undertaken by the foreign enterprise even though at that point of time the activity may only have been preparatory or auxiliary in nature. Maintenance of robust documentation corroborating the real nature of activities is extremely essential to mitigate such exposure.


Offshore supply

Supplies made offshore, conceptually should not give rise to tax implication in India [see end note 2]. The contracts at times indicate that the supply is complete and title over goods pass only after satisfaction of certain conditions in India.  In such cases, tax authorities have at times endeavoured to tax the offshore supply. This happens especially when there is a composite price [see end note 3] for the contract. In exceptional cases tax authorities have observed that consideration towards non-taxable offshore supplies is inflated so as to reduce the tax impact on taxable onshore activities [see end note 4]. A justification of price break-up (on the lines of a transfer pricing study) is imperative in such cases.

Offshore services such as design, drawings, documentation etc. constitute inextricable part of offshore supply and usually entitled for similar treatment. A detailed examination of the facts and documents in some cases has revealed that what is ostensibly a payment for assignment of design is in law a payment in the nature of fees for technical services and taxable under source rule.


Offshore services - Fees for technical services (FTS)?

Indian domestic law provides for source based taxation on consideration for services which are in the nature of managerial, technical or consultancy. Some of the Indian treaties also contain similar provision. It is pertinent to note that FTS is taxable in India on gross basis at the rate of 25% [see end note 5] or at the rate provided in relevant Double Tax Conventions ('DTC') [see end note 6], whichever is lower. Such services are usually excluded from the purview of Service PE but can be taxed as PE profits if the contract generating FTS is effectively connected with the PE. Some treaties, however, provide for a narrow definition of FTS and in such cases the consideration may not attract tax either as PE profit or as FTS.



As EPC projects involve huge amount of investment, MNEs need to be cautious in respect of the tax exposure and take necessary safeguards to optimize the tax cost. Careful drafting of the contracts, meticulous planning and diligent conformity of the conduct with the contract are key factors for keeping taxmen at bay.

[The author is a Senior Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, New Delhi]


End Notes:

  1. Samsung Heavy Industries Co. Ltd. v. ADIT, ITA No. 5237/Del/2010 (ITAT Delhi).
  2. Ishikawajima-harima Heavy Industries Ltd. reported at [2007] 288 ITR 408 (Supreme Court), CIT v. Hyundai Heavy Industries Co. Limited [2007] 291 ITR 482 (Supreme Court), DIT v. LG Cable Ltd. 237 CTR 438 (Delhi High Court), DIT v. Nokia Networks OY [2012] 253 CTR 417 (Delhi High Court), Joint Stock Company Foreign Economic Association 'Technopromexport', In re, 322 ITR 40 (Authority for Advance Rulings), Hyosung Corporation, In re, 314 ITR 343 (Authority for Advance Rulings), DCIT v. Roxon Oy. 291 ITR (T) 275 (ITAT Mumbai), Toshiba Plant Systems & Services Corp., Japan, In re, 332 ITR 456 (Authority for Advance Rulings).
  3. Linde AG, In re, [2012] 349 ITR 172 (Authority for Advance Rulings), Alstom Transport SA [2012] 349 ITR 292(Authority for Advance Rulings), Roxar Maximum Reservoir Performance WLL, In re, [2012] 349 ITR 189 (Authority for Advance Rulings).
  4. Ansaldo Energia SPA.
  5. Section 115A of the Income Tax Act, 1961.
  6. 0% to 25%.


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