Seven tax risks: Lump sum turn-key contracts in Thailand

The inefficiency of a lump sum turnkey construction contract under Thailand’s tax legislation

Thailand welcomes foreign construction companies for the erection of energy and infrastructure projects in the land of smile. From a commercial point of view, such big and financially strong foreign companies should be the offshore prime contractor under a lump sum turnkey contract (LSTKC).

Such agreement covers typically the engineering, building construction, delivery of components, erection and assembling, site supervision as well as the start-up and initial operations. The offshore prime contractor will involve subcontractors outside of Thailand and local subcontractors in Thailand. 

The tax disadvantage of such structure is, that the entire revenue under the contract with the local principal is exposed to Thai taxes. This relates mainly to these three aspects:

  • The sale of goods does not constitute a permanent establishment (PE), but in case of a combined LSTKC, the service part of the agreement constitutes a PE for the whole scope of deliveries and services.
  • Under Thai tax laws, there is no withholding tax on the sale of goods. However, in case of a combined LSTKC, withholding tax on the full remuneration amount is due. 
  • Withholding taxes can be credited against corporate income tax obligations if any. However, although a tax cash refund is in general possible, such request usually causes in an aggressive tax audit and should be avoided.

These three main tax aspects make it typically unattractive for the parties to enter into an LSTKC as recommended by the FIDIC Silver Book.

The contract split as an effective tax planning tool

To reduce the overall tax burden, a split of the entire agreement into an onshore contract with an (often small) Thai company and an offshore contract with the foreign offshore contractor at the headquarters is required. This results in a split of the contract, a split of the contractors and a syndicated offer.

  • The Thai onshore contractor, a Thai Co., Ltd., takes over the local engineering obligations. This includes local components, the erection respectively assembling, the building construction, site supervision, start-up and initial operations, procurement of onshore spare-parts as well as the onshore training of engineers and local staff in Thailand.
  • The offshore contract of the local principal with the offshore contractor covers offshore design and engineering, several components, ownership transferred outside of Thailand, and offshore spare parts.

If done correctly, the split has substantial tax advantages: With respect to the offshore contract, profits are taxed abroad and no withholding taxes are due. Regarding the onshore contract, profits are low, the low withholding tax rate of 3% is deductible against profits, and stamp duty, if any, is reduced to the service part. As a result, the split qualifies as a highly effective tax planning tool.

Umbrella and consortium agreement – and why both are required

The local principal has good reasons to feel uncomfortable with the split of the combined LSTKC. Businesswise, the separation of obligations, risks, and responsibilities, is not his benefit. Therefore, for his comfort, it is required to add another agreement to the onshore and offshore contract, which can be drafted in the form of a letter agreement and acts as an umbrella for the onshore and offshore part. It has mainly three purposes:

  • To assure that the service provider is financially capable to fulfill his obligations, including penalties and damage claims.
  • To assure that the buyer/employer has no problem to address the correct contractual partner for claims and information requests.
  • As a „horizontal defense“, it prevents the contractors from relying on the defaults of the other parties to avoid performing their contractual obligations.

As an additional contract, a consortium agreement has to be concluded between onshore and offshore contractor. It deals with the rights and obligations of each member (allocation of costs, risks, internal chargeback), as a secondment agreements (transfer of employees and internal costs allocation), as a financing agreement (stand-alone conditions, no collateral in the project, no reference to the project), as well as for the agreed procedures.The seven main tax risks of a split of the turn-key construction agreement

Under Thailand’s tax jurisdiction, the form of separate agreements is not easily overruled by the substance. However,  the split of the combined agreement into two parts – and the addition of two additional agreements – is a highly sophisticated task and requires a specific tax know-how. Otherwise, the split could be irrelevant from the tax perspective and result in an even higher tax exposure.

The Thai Revenue Department is currently increasing its efforts to avoid tax deficits in connection with the upcoming big infrastructure projects in the EEC, the OBOR-area and under the PPP-scheme. Experience shows, that Thailand’s tax authorities focus on seven weak points of the overall contractual structure:

#1. General misuse: If the split of the contracts is not made expertly, it will be qualified as artificial and irrelevant for the taxation of the entire venture. There are specific formal and material aspects which should be done right to avoid such judgment as misuse of tax-saving strategies. 

#2. Permanent establishment: The tax authorities will look for a Thai permanent establishment of the foreign offshore contractor in Thailand.

#3. Royalties: The services of the offshore contractor could be reclassified as royalties with a withholding tax rate of 15%.

#4. Transfer pricing: The remuneration of all participants has to be adjusted to arm‘s length principles. Thailands transfer pricing rules are currently under review by the government and much stricter guidelines can be expected soon.

#5. Umbrella agreement: A badly drafted umbrella agreement acts as a clamp which repeals and nullifies the effects of the split tax-wise.

#6. Non-disclosure: The umbrella agreement is typically not disclosed to the tax authorities. This is correct if it is really irrelevant tax-wise. Otherwise, the non-disclosure can be seen as participation in a tax crime. 

#7. Non-implementation: The clear and correct split of the LSTKC into onshore and offshore agreement has to be actually performed and executed to be relevant tax-wise. This requires a contract management under the supervision and monitoring of the tax lawyer.

Professional services for lump sum turnkey contract structures

PUGNATORIUS Ltd. is a Bangkok-based specialist provider of bespoke transactional legal and tax advice in the corporate and property legal and taxation industry sectors. The law firm provides international clients with these professional services:

  • Comprehensive tax structuring of the bundle of lump sum turnkey agreements
  • Split of the combined lump sum turnkey contract into onshore and offshore part
  • Drafting and negotiation of umbrella contract and consortium agreement
  • Tax (and legal) contract management of the overall construction process 
  • Non-tax aspects of the construction venture, including visa, work permit, foreign business license and more.

The firm provides strategic international tax advice and individually tailored tax planning solutions for the needs of a demanding corporate and private clientele from all over the world. Security in an insecure tax environment. Tax strategies for challenging times.


If you have any queries about what we do, or if you would like to approach us to discuss your legal requirements, please e-mail, message or call us using the details set out on the top of this page. 


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