Foreign permanent establishment exemption: what changes?

UK companies operating through overseas branches need to prepare for a significant change to the corporation tax rules. Budget 2026 confirmed the foreign permanent establishment exemption will become mandatory for accounting periods beginning on or after 1 January 2027. From this date, most UK companies with a foreign permanent establishment (“PE”), will no longer be able to choose whether to bring its profits and losses into the UK corporation tax calculation. Instead, the exemption will apply automatically.

In simple terms, foreign branch profits will generally fall outside UK corporation tax, but foreign branch losses will no longer be available to reduce UK taxable profits. That may sound relatively straightforward, but the effect can be quite different depending on whether an overseas operation is profitable or loss-making, where it operates and, crucially, how much profit should properly be attributed to it.

We advise UK businesses on international tax matters, including PEs, double tax relief and transfer pricing. One of the things I would encourage businesses with overseas operations to do now is look beyond the headline change and understand what it means for their particular overseas footprint.

The foreign permanent establishment exemption is changing

Under the existing rules, a UK resident company may be subject to UK corporation tax on the profits of its overseas branches. Alternatively, it can make an irrevocable election for the foreign PE exemption, broadly taking the profits and losses attributable to its overseas PEs outside the UK corporation tax calculation. From 2027 that choice will largely disappear.

The government’s concern is clear – it does not want overseas losses reducing UK taxable profits without necessarily collecting UK tax when the same overseas activities become profitable. That could happen where later profits are substantially covered by double tax relief, or where the overseas operation is transferred into a subsidiary once it becomes profitable.

The government estimates that the measure will raise approximately £450 million to £470 million a year. This reinforces why businesses should consider the change before 2027 rather than treating it simply as a year-end compliance issue.

Profitable branches may benefit from the new rules

For companies with profitable foreign branches, the change may be welcome. Take a UK company with an established branch in a jurisdiction where the effective local tax rate is materially below the UK rate. Under the existing regime, if the company has not elected into the exemption, the branch profit falls within the UK corporation tax calculation. Credit will generally be available for qualifying overseas tax, but there may still be a UK tax cost where the overseas tax is lower than the corresponding UK tax charge. From 2027, assuming the branch profit qualifies for exemption, it will instead sit outside the UK corporation tax charge.

Consider a simplified example. A foreign branch earns taxable profits of £1 million and pays local tax at 10%, giving an overseas tax charge of £100,000. If those profits are taxable in the UK at 25%, the starting UK liability would be £250,000. Subject to the detailed double tax relief rules, credit for the £100,000 of overseas tax could leave a further UK liability of £150,000. Under the mandatory exemption, the foreign PE profit would generally be outside UK corporation tax. The branch would still pay local tax, but there would not be the same UK top-up on its exempt profit.

There is an important qualification. Exemption does not mean that profits can simply be booked to an overseas branch. The amount removed from UK taxation depends on the profit that is properly attributable to the foreign PE. That makes arm’s length profit attribution considerably more important.

Arm’s length profit attribution will be central

A branch is not a separate legal entity from the UK company. For tax purposes, however, it is necessary to determine the profit the PE would earn if it were a separate enterprise carrying on the relevant activities. That requires a detailed understanding of what is happening on the ground. Businesses need to consider the functions performed by people in the overseas location, the assets used, the risks associated with those activities and where the important commercial decisions are made.

This is an area where some businesses could be caught out. Suppose a UK company has a branch in a relatively low-tax jurisdiction. A sales team may be based there, but the technology, intellectual property, senior management and strategic decision-making remain in the UK. It would not necessarily be reasonable to attribute a large proportion of the company’s overall profit to the branch simply because it manages customer relationships or because that produces a more favourable tax result.

The reverse can also apply. Where overseas personnel perform commercially important functions, manage material risks and use significant assets, allocating only a small routine return to the branch may not reflect the commercial reality. The tax treatment should follow how the business actually operates.

For businesses with material foreign branches, the basis for profit attribution should be documented before HMRC asks about it. The analysis should also be consistent with local filings and with the wider transfer pricing position of the group.

Loss-making branches face the biggest change

A UK business expanding overseas will not necessarily make money immediately. Establishing a local team, office or customer base often means incurring costs before the overseas activity becomes profitable. Currently, provided the company has not elected into the foreign PE exemption, losses attributable to an overseas branch can potentially reduce UK taxable profits. Under the mandatory exemption, future foreign PE losses will generally no longer be available in this way.

Consider a profitable UK company that establishes an overseas branch and incurs £1 million of branch losses while building the operation. Under the current regime, those losses might reduce UK taxable profits which could create a cash tax benefit could be up to £250,000. Once mandatory exemption applies, the same £1 million foreign PE loss will sit outside the UK corporation tax calculation. The economic loss remains, but there will be no immediate UK tax relief for it.

Therefore, whether relief is available in the overseas jurisdiction will become even more important. In some countries, branch losses may be carried forward against future local profits. In others, the timing or availability of relief may be restricted. This can materially increase the after-tax cost of international expansion. It also changes one of the tax distinctions between entering a new market through a branch and establishing a separate overseas subsidiary.

Existing branch losses require careful review

There is a further complication for companies that already have loss-making overseas branches. Losses and certain other amounts attributable to foreign PEs arising before commencement will be restricted so that they cannot simply be carried forward and used against UK profits arising once the new regime applies.

This makes the period before commencement particularly important for groups with significant unrelieved foreign branch losses, capital allowances or other relevant tax attributes. The answer is not simply to accelerate losses or restructure before 2027. The legislation contains targeted anti-avoidance rules, and artificial arrangements are unlikely to produce a reliable outcome. The government’s own fiscal costing assumes some businesses will increase their use of foreign branch losses before commencement, which suggests this area is likely to receive attention.  Businesses should instead establish what attributes they actually have, understand whether and when those amounts can be relieved, and model the position before and after commencement.

Businesses should review their overseas footprint now

The first question is a basic but important one: where does the company have permanent establishments? That is not always obvious. A PE can arise without establishing a formally registered branch. Overseas employees, offices, dependent agents, construction projects and people who habitually conclude contracts can all create a taxable presence, depending on the circumstances and the relevant double tax treaty.

Businesses should then review the profitability of each foreign PE, identify accumulated losses and other tax attributes, and revisit the basis on which profits are attributed between the UK company and its overseas operations. For a profitable branch in a lower tax jurisdiction, the new regime could reduce the overall tax charge. For an early-stage or loss-making overseas operation, the change could increase the after-tax cost of investment. In both cases, the result will only be reliable if the underlying profit attribution is supportable.

Finance teams may therefore want to ask their tax adviser whether all overseas PEs have been identified, whether current profit attribution reflects the people, assets and risks in each location, how existing branch losses will be treated, and whether a branch remains the right structure for planned expansion.

If your business has existing overseas branches, is considering entering a new country or has historically used foreign branch losses against UK profits, we can review the potential impact before the new regime takes effect. That should include modelling the cash tax position, considering the transitional rules and checking that the allocation of profit to each foreign PE remains consistent with the commercial reality.