Tax exemption for foreign branches

Later this year, UK companies will be given the opportunity to elect for UK tax exemption on future profits and losses of trading activity they carry on outside of the UK.

Companies carrying on a trade in another territory are referred to as having a foreign branch. Present UK tax rules mean that a UK company with a foreign branch pays tax on the results of the branch in two countries. The country in which the branch is located will tax the results and, as the company itself is resident in the UK, the results of the branch form part of its overall profit or loss for UK corporation tax. Relief is given for this double tax by the company claiming a deduction against its tax bill for overseas tax paid. This means the branch suffers tax at the higher of rate of the overseas and UK corporation tax rate.

The Finance Act 2011 will contain legislation permitting UK resident companies to elect that the future results of their present and future non-UK branches be excluded from UK taxable profits. The election is irrevocable. It will become available this year at a date yet to be decided.

On making the election, a UK large or medium sized company will be exempt from UK tax in respect of future profits and losses of all its non-UK branches, with the exception of some branches located in tax havens. The exemption for companies that are small will be restricted to branches located in territories with which the UK has a comprehensive double tax agreement.

The exempt profits or losses of a foreign branch of a UK company will comprise:

  • Trading profits (or losses).
  • Investment income of the branch
  • Gains on capital assets that are taxed in the non-UK territory

However, the rules also cover recapture of past UK tax loss relief, broadly within six years of making the election, but potentially longer if large losses were incurred. The election will not be available to branches whose business is wholly or mainly investment business. Neither will it apply to non-corporate taxpayers such as partnerships or LLPs trading outside of the UK.

The exemption has upsides in the exclusion of profits for tax but downsides in excluding UK tax relief for losses. Once the election for exemption is available, careful examination of each company’s own particular present and expected future circumstances will be required to decide whether or not to elect, especially given that the election is irrevocable once made.

Please contact Richard Service, David Sayers or Dominic Pickard or if you would like to discuss this further.