Making the foreign branch exemption compulsory

The government has announced that, for accounting periods beginning on or after 1 January 2027, UK resident companies with a foreign permanent establishment (PE) will be required to exempt the profits and losses from those PEs. For UK-resident companies that conduct activities in relation to oil and gas extraction and exploration through foreign PEs this measure will apply from 1 September 2026. The change is designed to prevent losses attributable to such foreign PEs being utilised in the UK whilst foreign profits are not similarly taxed.

Background

Under the current rules, introduced in 2011, a UK resident company operating abroad through a PE may make an election to exempt the profits of its foreign PEs (the foreign branch exemption). In the absence of such an election, the PE profits are subject to UK tax (subject to the provisions of any applicable double tax treaty). Such elections are irrevocable and require the company to determine whether losses were made in the years prior to the election, in which case an equivalent amount of profits must be brought into charge in the years following the election.

Under the current rules, where an election has not been made, the foreign losses of a UK company attributable to its foreign PE are available to be used to relieve UK profits of the main company or the wider group. However, the government is concerned that this relief is not being appropriately balanced by equivalent foreign profits being brought into the charge of UK tax as intended by the original rules. In some cases this is because the UK profits are largely or fully sheltered by the availability of double taxation relief and in other cases a multinational group may incorporate a foreign PE at the point that it becomes profitable, which removes those profits from the charge to UK tax without the transfer of the PE business generally giving rise to a taxable gain.

According to the announcement, the result is that “the UK Exchequer is in some cases compensating multinational groups for costs/losses incurred overseas through reduced UK tax on UK profits, without corresponding tax being collected on their foreign profits. This effect is particularly significant for groups which generate very large foreign losses or are able to claim very large amounts of capital allowances in relation to their foreign PEs, for example in the oil and gas sector.”

Proposed changes

The government has announced that it will make the foreign PE exemption mandatory, generally with effect for accounting periods beginning on or after 1 January 2027. However, for UK-resident companies with foreign PEs that carry on activities in connection with the exploration or exploitation of oil and gas, this measure will commence from 1 September 2026. The changes will prevent any losses arising in foreign PEs after that date from being offset or relieved against UK profits. This will be achieved by deeming the accounting periods of such companies to end on 31 August 2026, with the new regime applying from the following day.

Transitional rules will be amended such that losses and other attributes arising in years before exemption takes effect will not be available to relieve UK profits of the company or the wider group arising after the effective date.

The existing legislation taxing profits of an exempted foreign PE where there is a ‘total opening negative amount’ will be repealed.

The changes will be accompanied by an anti-avoidance rule intended to prevent arrangements which would seek to artificially accelerate the utilisation of such losses or other attributes or otherwise minimise the impact of these changes.

Next steps

These changes will be published in draft legislation over the summer.