The Chancellor announced today a fundamental change in the way that losses and profits of foreign branches of UK resident companies are to be relieved and taxed in the UK.
Under the current rules, a UK group has a choice as to whether to hold their overseas interests through a non-UK resident subsidiary, in which case those activities will generally be outside the UK tax net, or through a branch of a UK company. In the case of a branch or branches of a UK company, the profits and losses are fully within the scope of UK corporation tax, but the UK company has the option to make a foreign branch exemption election, which results in losses and profits being outside the scope of UK tax.
Measures are to be introduced to make the foreign branch exemption compulsory for all foreign branches. These measures will apply to all foreign branches with effect for periods beginning on or after 1 January 2027, but for oil and gas extraction and exploitation companies, the measures will apply from 1 September 2026.
The measures are intended to close a perceived loophole which arises as a result of the UK’s worldwide taxation approach. In particular, UK resident companies are entitled to claim tax relief for branch losses, but it is not always clear whether future profits of the branch will be brought within the tax net.
For example, during the early phases of a branch’s lifecycle, losses can be generated from exploration, appraisal and development activities, and these will generally be deductible for UK tax purposes, whilst subsequent profits, arising from the same branch, may not fall within the UK tax net. This outcome can arise either because overseas tax rates are high such that foreign tax credits fully shelter the UK tax on such profits or the branch is exported to a non-resident company or a foreign branch exemption election is made. Although the export of a branch is a disposal event for certain capital allowance purposes as well as capital gains tax purposes, these rules may leave a net deduction within the UK tax net, and of course if the branch activities are ultimately unsuccessful, UK tax relief is potentially available without any prospect of UK tax clawback.
Although branch exemption elections require opening negative amounts to be tracked and the exemption cannot apply until those amounts have been effectively used up, these current rules can in certain circumstances lead to asymmetric tax treatment from the UK point of view.
Amendments to the current foreign branch exemption regime are to be made to accommodate changes such as the abolition of the opening negative amount rules.
The draft legislation required to introduce the new measures announced today is not yet available.
Companies with foreign branches will need to carefully review their planning positions, particularly where exploration and appraisal costs were expected to provide shelter against UK profits in future years.