Linklaters to Paul Wurth: changing contours of India’s force of attraction rule

The recent decision of the Delhi Bench of the Indian Income Tax Appellate Tribunal (the Tribunal) in Paul Wurth Italia marks an important development in the application of the force of attraction rule under Article 7 of certain tax treaties.

The Tribunal declined to attribute offshore supply profits to India despite the existence of an admitted supervisory permanent establishment (PE), emphasising that the application of the force of attraction rule cannot be divorced from the factual role played by the PE itself. In doing so, the Tribunal reaffirmed that the mere existence of a PE is insufficient to justify taxation of all source-country profits and that a demonstrable nexus must exist between the PE and the income sought to be taxed.

Traditionally, business profits under tax treaties are taxable in the source state only to the extent attributable to a PE located in that state. This principle, reflected in Article 7 of the OECD Model Tax Convention on Income and on Capital, restricts source-state taxation to profits arising from activities actually carried on through the PE and rejects the force of attraction principle.

In contrast, the UN Model Double Taxation Convention adopts a broader source-based approach by allowing the source state to tax not only profits attributable to the PE but also profits arising from sales or business activities of the same or similar nature as those carried on through the PE. This limited force of attraction rule reflects the UN model’s objective of preserving greater taxing rights for source countries, particularly developing economies, while ensuring that the entirety of profits earned by the enterprise are not taxed in that state.

Most Indian tax treaties incorporate the above limited force of attraction language. Consequently, disputes in Indian jurisprudence have centred more on the scope of the rule, particularly whether the profits sought to be taxed bear a sufficient similarity and nexus to the activities carried on through the PE.

Indian jurisprudence on the force of attraction principle has evolved through a series of decisions examining when a source state may tax profits not directly attributable to a PE. The foundation was laid by the Supreme Court in Ishikawajima (2007), which held that profits could be attributed to a PE only if the PE was involved in the activities generating those profits. The mere existence of a PE did not justify taxation of all income arising from a composite contract. This principle was reaffirmed in Hyundai Heavy Industries (2007), LG Cables (2010), and Roxon OY (2006).

A departure from this approach emerged in Linklaters (2010), where the Tribunal interpreted the phrase “directly or indirectly attributable” in Article 7(1) of the India–UK treaty as incorporating a force of attraction rule. It held that profits from Indian projects involving the same or similar activities could be taxed in India even if the services were rendered directly by the head office.

However, in Clifford Chance (2013), the court rejected this interpretation, holding that the India–UK treaty did not contain a force of attraction rule. Accordingly, the existence of a PE could not extend India’s taxing rights to profits arising from activities undertaken independent of the PE.

The broader approach in Linklaters was later adopted in Shanghai Electric (2017), where the Tribunal treated offshore supply and supervisory functions as part of an integrated commercial arrangement and attributed profits from similar activities undertaken for Indian projects to the PE. The decision emphasised the economic connection between offshore and onshore activities rather than the PE’s direct involvement in generating the profits.

Against this backdrop, the ruling in Paul Wurth on August 7 2026 is significant. The assessee, an Italian company, had separate contracts for offshore supply and onshore supervisory services and admitted the existence of a supervisory PE in India. Nevertheless, the Tribunal held that offshore supply profits were not taxable in India because the PE had no involvement in the activities generating those profits. In doing so, it reaffirmed that even where the force of attraction principle is invoked, a demonstrable functional nexus between the PE and the income remains essential.

In light of the above developments, the force of attraction principle appears to be evolving rather than diminishing. The legislative trajectory of Indian domestic tax law has progressively expanded source-based taxation. In 2010, the law was amended retrospectively from 1976 to neutralise the territorial nexus requirement recognised in Ishikawajima and significantly broaden India’s taxing jurisdiction over interest, royalty, and fees for technical services, while broader attribution principles continued to influence the interpretation of Section 9(1)(i) of the Income-tax Act and treaty-based PE attribution.

The foregoing judicial developments reaffirm that attribution remains central even where a treaty incorporates a force of attraction rule. This assumes particular significance in the context of Rule 10 of the Income-tax Rules, 1962, which operates as an attribution mechanism for determining profits reasonably attributable to operations carried out in India. Unlike a force of attraction provision, Rule 10 does not expand the scope of taxable profits but merely provides a method for quantifying profits once a taxable nexus has already been established. This raises the question of whether the scope of taxable profits is determined by the treaty alone or may also be influenced by domestic attribution principles.

The emergence of significant economic presence (SEP) in Indian domestic law creates a further issue. While SEP expands domestic nexus standards through economic and digital participation, business profits in treaty situations continue to be governed by PE provisions. This raises an important question: to what extent can the expansion of domestic source-based taxation through SEP coexist with treaty provisions that continue to predicate taxing rights on the existence of a PE and, in some cases, on the operation of a force of attraction clause.

The significance of Paul Wurth lies not in rejecting the force of attraction rule but in recalibrating its application. The decision shifts the focus away from mere existence of a PE towards a more principled enquiry centred on nexus, involvement, and attribution. Whether this approach will continue to shape the interaction between force of attraction provisions, Rule 10, and emerging nexus standards such as SEP remains a question that future jurisprudence may be called upon to answer.