Draft legislation confirms mandatory foreign branch exemption

When the government announced in May that the foreign branch exemption (FBE) would become compulsory, the headline impact was clear: Profits and losses of overseas permanent establishments (PEs) would no longer form part of the UK corporation tax calculation. Draft legislation published on 13 July 2026 confirms that approach and provides additional detail on how the new regime will operate from accounting periods beginning on or after 1 January 2027.

As discussed in our previous article, the move represents a significant shift towards a more territorial system of taxation for overseas branches. Companies that have historically relied on foreign branch losses to reduce UK taxable profits will no longer be able to do so, while foreign branch profits will cease to be subject to any UK “top-up” tax.

The draft legislation removes the elective nature of the FBE regime and replaces it with a mandatory exemption. In practice, this means that all qualifying foreign branch profits and losses will be excluded from UK corporation tax computations, regardless of whether a company would previously have chosen to make an election.

For many businesses, the practical consequence will be the loss of relief for overseas branch losses and capital allowances against UK profits. This may be particularly relevant for groups investing in new overseas territories where losses often arise before a business becomes profitable. Other impacted businesses, as we previously noted, will be those that undertake qualifying R&D activity via their overseas PEs.

One notable addition in the draft legislation is a bespoke definition of PE for the purposes of the exemption. Rather than relying on the UK’s domestic PE definition, the legislation provides that the existence of a foreign PE will be determined by reference to the relevant double tax treaty or, where no treaty exists, the OECD Model Convention.

This is an anti-avoidance feature. Without it, a business could have had sufficient presence overseas to constitute a PE under the UK domestic definition, but not under the provisions of the relevant double tax treaty. In those circumstances, profits might otherwise have fallen outside the scope of tax in both jurisdictions. The new rule appears designed to ensure that such non-treaty qualifying branches remain within the charge to UK corporation tax and do not escape taxation entirely through mismatched definitions.

The draft legislation also contains provisions restricting the use of carried-forward losses attributable to foreign PEs. Income and capital losses may be restricted by reference to a six-year lookback period.

This is a notable development. Some businesses may have expected historical branch losses to remain available even after the exemption became compulsory. The draft legislation indicates that this will not be the case, preventing companies from obtaining future UK tax relief for losses arising from activities that will sit outside the UK tax net going forward.

As with the current FBE, certain PE profits will not be exempt from UK corporation tax under the new regime, including profits attributable to dealing in UK land or a UK property business. Any losses restricted under the new rules would still be available for offset against non-exempt PE profits.

Ultimately, the broad policy direction was already known, but the draft legislation provides important confirmation and introduces additional measures to prevent gaps arising from differing PE definitions and the continued use of historical branch losses.

While businesses with overseas branches will need to review both their current tax position and future forecasts, factoring in consideration of whether any carried-forward losses could be restricted by the transitional rules, they shouldn’t lose sight of the fact that branches remain a viable option for conducting overseas activities.

For some businesses, reduced local filing requirements, simplified administration and local legal and regulatory considerations could still make a branch preferable to a separate legal entity. For others, these changes may mean that incorporating a local legal entity is now the better option. No one size fits all.