Tax changes for overseas permanent establishments

It is a long-established principle that UK tax resident companies are subject to corporation tax on their worldwide profits. The UK does not have a territorial tax regime that taxes only profits earned in the UK. Instead, it taxes the profits of resident companies wherever they are earned, subject to double tax relief and the foreign branch exemption (FBE) election, which allows companies to elect to have the profits of their foreign branches or permanent establishments exempt from UK Corporation Tax. 

That looks set to change, however. The government announced on 21 May 2026 that profits and losses attributable to overseas permanent establishments (PEs) will soon be automatically exempt from corporation tax.  

At present, a UK company with an overseas PE is automatically subject to corporation tax on the profits of that PE. However, it is possible to exempt those profits by an FBE election. The government’s announcement indicates that the FBE will become mandatory for accounting periods beginning on or after 1 January 2027. For certain companies conducting oil and gas exploration and extraction activities, an earlier commencement date of 1 September 2026 applies. 

This will impact all UK companies with overseas PEs that are not already exempt by election. The mandatory application of the FBE will mean that the overseas losses and tax attributes cannot be offset against UK taxable profits. Likewise, foreign profits will not be taxed in the UK and will therefore no longer be effectively “topped up” where the foreign tax rate is lower. 

Furthermore, this could also reduce a company’s R&D claims. It could have a significant impact for research-intensive businesses. 

On an initial reading of the announcement, the mandatory application of FBE will exclude the R&D expenditure of those overseas PEs from UK R&D tax relief claims. That will impact the many UK companies that include specialist staffing costs from their overseas PEs in their R&D tax relief claim, as this may no longer be possible.  

The value of R&D tax relief claims could therefore significantly reduce, which would be the second reduction in recent years for affected businesses following changes regarding overseas contractors and externally provided workers. 

Despite the change, it’s important to note that transfer pricing remains as important as ever.  

A UK company will still be expected to deal with its overseas branches on an arm’s length basis for tax purposes, and affected companies will still be required to maintain appropriate policies and documentation. 

We are awaiting the draft legislation, which is expected in the summer. This should include full details of how the measure will be implemented. Once published, businesses should be able to evaluate the expected impact on their tax profile in future periods. They should also have an opportunity to provide feedback on the proposals before the legislation is finalised. 

Businesses may not wish to wait until then to act, however. Existing business plans and projections may include future R&D tax relief claims or loss offsets that will no longer be possible. While we await the legislation, companies can be updating these in light of the announcement to avoid nasty surprises in the future. 

Approval code: NTAB052623