Attributing Profits to an Indian Project Office: Which Head Office Expenses Count?

By CA Mithilesh Reddy, Founder and CEO, and CA Rajesh Vaishnav, Partner, Steadfast Business Consulting LLP | Direct Tax Litigation / Controversy

Introduction

An engineering contract can be negotiated in one country, designed in another and executed partly through a project office in India. The commercial profit is earned by the combined enterprise, but a tax treaty does not permit the whole amount to be assessed in the source country simply because the work culminates at an Indian site.

The permanent establishment question determines whether India has an Article 7 taxing right. Attribution then asks a different question: what profit is economically connected with the functions, assets and risks of that establishment? The second question is difficult where project-management charges, engineering design, procurement, insurance, finance and central support are booked outside India.

This note concerns the evidence required to defend a claim for expenses incurred by a foreign head office for the purposes of an Indian project office. Its focus is the factual explanation of expenditure and the attribution mechanics, not an assumed right to deduct a percentage of consolidated revenue.

1. The two-stage Article 7 enquiry

First determine whether the enterprise has a permanent establishment under the applicable treaty. The site, fixed-place, service or agency clauses can differ materially across treaties. Only after a PE is established should the practitioner consider profits attributable to it; the mere existence of a PE does not make all receipts of the non-resident taxable in India.

Article 7 generally focuses on business profits attributable to activities of the PE. Read the authentic treaty text, including any protocol, alongside domestic statutory limits. The Income-tax Department treaty repository is a suitable starting point, but the specific convention controls.

2. Map the actual project before selecting a formula

Project records should show where design approvals took place, who procured specialised components, who bore warranty and performance risk, who supervised construction, and who controlled client variations. A head office may perform central technical or commercial functions of real value even when the project office interacts with the customer each day.

An allocation based only on time sheets or employee location can miss responsibility for engineering risk, contract negotiations and technology. Conversely, a foreign head office may hold contractual authority without performing the functions attributed to it. The record must distinguish legal labels from operational conduct.

3. Differentiate direct and shared expenditure

Direct costs can often be traced to project-specific design drawings, subcontractor bills, travel schedules or procurement orders. Shared costs, such as global engineering support and management, require a principled allocation key. Project hours, headcount, contract value or engineering deliverables may each be suitable in particular circumstances; none is automatically correct.

The allocation should be applied consistently, exclude unrelated group costs and reconcile to the foreign entity’s financial statements. A management certificate describing a single arbitrary percentage, without ledger detail and evidence of benefit, invites disallowance.

4. The treaty clause and domestic limitations must be read together

Article 7 treaties do not all contain identical wording on executive and general administrative expenses, reimbursements or dealings between a PE and its head office. Some treaty provisions expressly address expenses incurred outside the source State. The terms of the specific treaty must therefore be set out in the submission rather than inferred from a general OECD description.

Domestic provisions on head office expenditure may impose limits and definitions. The treaty benefit analysis must distinguish a substantive permission to recognise relevant expenditure from any domestic limitation that continues to apply. It is particularly important not to transplant language from another convention into the treaty that actually governs the dispute.

5. Cost reimbursement is not automatically profit attribution

A head office debit note may reimburse a cost, apply a mark-up or purport to remunerate a function. These are different economic claims. A cost charged at actual value needs evidence it was incurred and relates to the PE. A mark-up requires a separate explanation of function, value and the treatment permitted under the relevant treaty.

Intercompany-style transfer pricing principles may inform the functional assessment, but the PE and head office are legally parts of one enterprise. An accounting charge between them does not necessarily have the same tax consequences as a payment between distinct companies.

6. Avoid gross-receipt attribution by default

An assessment sometimes begins with the Indian contract value and applies an estimated profit rate without examining where value was created or what costs were incurred. A presumptive rate, where a particular statutory regime applies, has its own conditions. Outside that regime, an estimation should not replace available project accounts and contemporaneous evidence without explanation.

The taxpayer should reconcile site revenue, milestone billing, advances, change orders, retention amounts and all project costs. The allocation narrative must explain any differences between invoicing location, accounting recognition and functions actually performed.

7. Construct an auditable project file

Useful primary evidence includes the signed EPC or services contract, scope split, tender and approval records, purchase orders, engineering deliverables, project-office trial balance, head office ledgers, time allocation records, travel documents, invoices, inter-office charge notes and proof of payment.

For each claimed expenditure, an indexed schedule should capture cost centre, vendor, service description, period, Indian project connection, allocation method and documentary reference. Do not allow duplicated charges at the project office and head office level; the reconciliation should specifically detect them.

8. Procedural representation and outcome implementation

Explain the governing Article 7 interpretation before debating amounts. Present the functional matrix, followed by reconciled schedules and supporting documents. A short narrative on why a chosen allocation key follows the commercial facts is usually more useful than a large set of vouchers submitted without index.

If an adverse adjustment reaches the appellate stage, distinguish rejection of a legal method from defects in the evidence. Preserve alternate computations where supportable and seek consequential interest and credit relief. After an appellate decision, verify the giving-effect order and the resulting demand ledger.

Section 44C and the Supreme Court’s December 2025 ruling

Section 44C of the Income-tax Act, 1961 limits the deduction a non-resident can claim for head office expenditure against its business or professional income in India. The cap is the lower of five per cent of the adjusted total income (the average adjusted total income where there is a loss) and the head office expenditure attributable to the Indian business. For years under the 1961 Act, any treaty argument for deducting head office costs has to be read against this ceiling.

In Director of Income Tax v. American Express Bank Ltd., decided on 15 December 2025, a Division Bench of the Supreme Court held that head office expenditure incurred outside India falls within section 44C even where it is incurred exclusively for the Indian branches, and that the section restricts deductions rather than conferring them. The earlier Bombay High Court line distinguishing common from exclusive expenditure was not followed. Reports differ on whether the Court also remitted the question of which expenses fall within the enumerated categories, so the judgment should be read before it is relied on. Whether a given treaty’s Article 7 paragraph on expenses overrides the ceiling depends on that treaty’s wording and is a separate argument.

Documentation checklist for a project office attribution file

The file should allow a reviewer to follow each rupee from the Indian contract to the foreign ledger. At a minimum: the signed contract with the scope split and pricing of each component; the Indian project office trial balance and ledgers; the foreign entity’s ledgers and audited accounts; a schedule of every inter-office charge note with the period, the function, the allocation key and proof of payment; engineering deliverables and design approvals showing where the work was performed; purchase orders and subcontractor invoices; and time and travel records for head office personnel who worked on the project.

Add a one-page functional matrix that lists each function (design, procurement, project management, finance, warranty risk) against the entity that actually performed it, with a reference to the supporting documents. The matrix is the bridge between the legal argument on Article 7 and the numbers, and it exposes inconsistencies before the Revenue finds them.

Common mistakes in attribution assessments and appeals

The first mistake is claiming a percentage of contract value as head office cost without ledger detail. The second is treating the project office accounts as the whole answer when the same cost appears in a head office charge, so that it is claimed twice or not at all. The third is arguing the legal method and the evidence in one undifferentiated submission, so that an appellate authority that rejects the method also dismisses the evidence. The fourth is ignoring section 44C, or assuming a treaty deduction removes it, without reading the treaty text.

A fifth mistake is taking inconsistent positions on whether the contract is composite. A taxpayer that argues the contract is indivisible to support a cost deduction cannot comfortably argue elsewhere that the supply and the installation are separate. The Tribunal decisions in Voith Paper and Andritz AG illustrate how the composite nature of a contract cuts in both directions.

How a dispute usually moves forward

For a foreign company, or a non-resident that is not a company, a proposed variation prejudicial to the assessee is first set out in a draft assessment order and can be taken to the Dispute Resolution Panel under section 144C of the 1961 Act (section 275 of the 2025 Act). Where that route does not apply, the first appeal lies to the Commissioner (Appeals) and then to the Tribunal. At each stage, ask for the computation to be redone on a net basis if any profit is held attributable, and keep an alternative computation ready.

Conclusion

PE attribution is not an exercise in choosing the most plausible percentage of project turnover. It is a disciplined account of the business carried on through the Indian establishment, set against the functions retained outside India.

The most persuasive allocation is one a reviewer can reconstruct from contemporaneous records. It identifies the cost, the benefit, the allocation key and the connection with the project, while remaining faithful to the words of the relevant treaty.

Frequently asked questions

1. Does every project office constitute a PE?

No. The treaty definition and the actual duration, premises and activities must be examined.

2. Can engineering work outside India reduce Indian attribution?

It can be relevant where genuinely performed outside India and supported by evidence, subject to the governing treaty and attribution method.

3. Are all global management charges deductible?

No. Purpose, project relevance, allocation, treaty terms and domestic restrictions must be tested.

4. Is a head office invoice sufficient evidence?

No. The underlying functions and actual costs should be substantiated.

5. What is the most useful document in an attribution defence?

A reconciled project-specific cost and function matrix with source records is often the strongest starting point.

6. Does section 44C apply to head office expenses of a permanent establishment in India?

Section 44C of the 1961 Act limits the deduction of head office expenditure by non-residents to the lower of five per cent of adjusted total income and the amount attributable to the Indian business. In American Express Bank (15 December 2025) the Supreme Court held that it applies to expenditure incurred outside India, whether common or exclusive. Treaty wording may add a separate argument.

7. How are profits attributed to a permanent establishment in India under Article 7?

Article 7 allows India to tax only the profits attributable to the permanent establishment, generally computed on a net basis by looking at the functions performed, assets used and risks assumed through the Indian establishment. The OECD 2010 report on the attribution of profits to permanent establishments sets out the commonly used approach, but the specific treaty text and Indian law govern.

8. Can a foreign head office charge a mark-up to its Indian project office?

Not as a matter of course. A head office and its permanent establishment are parts of the same enterprise, so an internal charge does not have the same tax effect as a payment between separate companies. Actual costs incurred for the project can be relevant if proved; a mark-up needs a separate basis under the specific treaty and Indian law.

Related reading from SBC

• No FTS Article in the India-UAE Treaty: How Offshore Engineering Income Is Taxed in India
• Digital Platforms and India Tax Once the Equalisation Levy Is Gone: SEP, Treaty and PE Compared
• Seconding Staff Between India and the UK: Employer, Permanent Establishment and Payroll Tax Are Different Questions
• More articles on the SBC blog

Disclaimer

This article is general professional commentary and not advice on any particular facts. Treaty eligibility, applicable law, procedural requirements and statutory amendments must be verified for the relevant tax period. It is not a description of an identifiable client engagement.