Indian tribunal narrows scope of force of attraction rule in offshore profits taxation

The Delhi Income Tax Appellate Tribunal’s ruling on Paul Wurth Italia signals a shift towards a more restrictive application of the force of attraction principle, emphasising the need for a demonstrable nexus in taxing offshore profits linked to Indian permanent establishments.

The Delhi Bench of the Indian Income Tax Appellate Tribunal has sharpened the debate over how far India can go in taxing offshore profits when a foreign company also has a permanent establishment in the country. In Paul Wurth Italia, the tribunal declined to bring offshore supply income into the Indian tax net, even though the company had an admitted supervisory permanent establishment, underscoring that the existence of a local presence alone does not automatically justify taxing all profits linked to an Indian project.

According to analysis of the ruling published by International Tax Review and Legal 500, the tribunal’s reasoning turned on function and fact rather than form. It found that the offshore supply profits could not be attributed to India because the permanent establishment had not played a role in generating those earnings. That approach matters because many Indian tax disputes have centred on whether treaty language allowing profits to be taxed where they are “directly or indirectly attributable” can be read broadly enough to capture sales or supplies made from abroad when a connected project exists in India.

The decision sits within a long and uneven line of Indian cases on the so-called force of attraction rule. Earlier Supreme Court rulings, including Ishikawajima and Hyundai Heavy Industries, were read as limiting Indian taxation to profits tied to activities actually carried out through the permanent establishment. Later decisions, including Linklaters and Shanghai Electric, were seen by some commentators as favouring a wider reading that could pull in profits from similar or related work even when parts of the contract were performed offshore. By contrast, Clifford Chance pulled back from that broader view, holding that the India-UK treaty did not contain such an expansive rule.

What makes Paul Wurth especially significant is that it does not reject the force of attraction principle outright. Instead, the tribunal appears to have narrowed its practical reach by insisting on a demonstrable nexus between the permanent establishment and the income sought to be taxed. That distinction is likely to matter in future disputes involving split contracts, where offshore supply and onshore services are separated on paper but form part of the same commercial arrangement. It also adds to the pressure on tax authorities to show not just that a foreign enterprise has a permanent establishment in India, but that the Indian presence was materially involved in producing the disputed profits.

The broader policy context is equally important. Indian tax law has, over time, moved towards a more source-based approach, including changes aimed at widening the country’s reach over certain income streams and the introduction of significant economic presence rules for some domestic purposes. Even so, treaty cases continue to turn on the wording of the relevant agreement and on traditional permanent establishment analysis. As the commentary on Paul Wurth notes, that leaves unresolved the tension between a domestic framework that increasingly favours wider source taxation and treaties that still tie business-profit taxation to a defined and provable connection with an Indian permanent establishment.