The UK Government has announced that profits and losses attributable to a foreign permanent establishment (PE) of a UK based company will be automatically exempt from UK corporation tax.
The new rules will apply to most companies with accounting periods beginning on or after 1 January 2027. However, for UK based companies with PEs connected with oil and gas, this date will be brought forward to 1 September 2026.
What is a permanent establishment?
UK tax resident companies have a foreign PE when they have an overseas taxable presence. Common examples of this are an office or factory located overseas, a member of staff working remotely from their home abroad or if you employ a sales person in another territory.
Because PEs are part of the UK company, there are complicated rules in place to determine what part of the company’s profit can be allocated to the PE.
Under the current rules, profits and losses arising on these overseas activities are automatically included within the scope of UK corporation tax. This means the same profits can be taxed twice. Double taxation relief has historically been available for foreign tax suffered on the PE profits, or alternatively, an election can be made to exclude all PE profits and losses from UK corporation tax.
However, many groups have previously decided not to elect, as the ability to offset their UK profits with losses generated overseas by foreign PEs has been highly beneficial.
What is changing in UK permanent establishments?
The UK Government intend to replace the existing elective regime with a mandatory exemption. It is likely these rules will be implemented by treating UK based companies with foreign PE’s as though they had made the exemption election on the day the rules come into force.
Companies which are currently using foreign PE losses to reduce tax on UK profits may see a higher corporation tax liability.
We anticipate that complicated transitional arrangements will also be introduced that may affect how you use losses. Restrictions will be imposed on foreign PE losses generated before the effective date, as well as anti-avoidance rules being introduced to prevent efforts to accelerate the use of losses ahead of the change in rules.
These changes are expected to impact the deferred tax asset position.
What should you do next?
Think about whether any overseas activities might constitute a PE.
UK companies with foreign PEs should review their current business structures to consider if these rules will affect their UK corporation tax planning. Affected businesses should consider whether it may be beneficial to restructure their overseas operations.
For companies considering overseas expansion, care should be taken as to how these tax changes could be impacted by the proposed commercial structure.
UK companies should revisit how profits have been attributed to the foreign PE by applying the arm’s length principle, considering the appropriate allocation of risk and cost margins across the company’s business activities. They should also seek technical consultants that can guide their business through this complicated change.
Every company is different and these changes to the foreign PE rules will manifest challenges differently for each business. Hazlewoods adopts a bespoke and practical approach to international tax compliance. If you would like support reviewing your PE position or understanding how the new rules may affect your business, our specialist team is here to help.