The end of optional: HMRC's mandatory foreign PE exemption
Since 18 July 2011, an election can be made to treat foreign branches as exempt from UK taxation. One of the objectives of the exemption was to tax foreign branches in the same way as foreign subsidiaries. Where a branch is located in a jurisdiction with lower tax rates, one benefit of the exemption is to cap the profits of the branch to the overseas corporate tax rate. The downside of electing for this exemption is that any losses in the branch are no longer included in the UK results for tax purposes.
A significant reform to this regime is due to take effect from early 2027 - with an earlier start for oil and gas businesses. This change will fundamentally alter how overseas permanent establishment (PE) profits and losses are treated for UK tax purposes.
What’s changing?
On 21 May 2026, HMRC announced that the foreign PE exemption, currently an irrevocable election, will become mandatory for most UK-resident companies. From next year for most businesses and September 2026 for companies involved in oil and gas, profits and losses of overseas branches will be automatically exempt from UK corporation tax. As a result, companies will no longer be able to use foreign branch losses to shelter UK profits.
Why the change?
The Treasury has identified a structural asymmetry in the current regime. Groups that had not made the exemption election could use overseas branch losses to reduce their UK corporation tax liability, then subsidiarise the branch once it became profitable – removing those profits from the UK tax net
The Treasury was, in effect, compensating companies for overseas costs without collecting a corresponding share of overseas profits. This issue is more prominent in the oil and gas sector, where large overseas capital allowance claims could substantially reduce UK tax even in years of elevated UK profitability.
Who is affected and when?
For UK-resident companies with foreign PEs, this change will take effect for accounting periods beginning on or after 1 January 2027. Where the company carries on activities in connection with the exploration or exploitation of oil and gas, this measure will take effect from 1 September 2026. We expect that this means the accounting periods of these companies will end on 31 August 2026. Any losses arising in overseas oil and gas PEs after that date cannot be offset against UK profits.
Transitional rules
Transitional rules will be amended so that losses and other tax attributes built up before the exemption takes effect will not be available to relieve UK profits after the rules take effect. Anti-avoidance measures will also prevent any attempt to artificially accelerate the use of those losses before the relevant commencement date.
What stays the same?
The reform is targeted at the loss offset asymmetry, not at the competitiveness of the UK's outbound tax regime. Foreign branch profits will continue to be exempt from UK Corporation tax, the same treatment that many overseas jurisdictions already apply. Certain complexities in the existing foreign branch election – such as the 'total opening negative amount' charge on elected PEs – will be repealed.
Why PE status now matters more
The move to a mandatory exemption makes PE determination more commercially significant than it has ever been for UK businesses. Under the current optional regime, many companies have been relatively indifferent to whether their overseas activity technically constitutes a PE. If no election had been made, foreign income and losses simply flowed through the UK Corporation tax computation, with double tax relief claimed on any foreign tax suffered. PE status was largely a question of foreign compliance, not UK loss planning.
That changes under mandatory exemption. If a business has an overseas PE, including one it has never formally recognised, the new rules will automatically ring fence the profits and losses of that PE outside the UK charge. For loss making overseas operations, that means losing the ability to use those losses against UK profits.
Common triggers for an inadvertent PE include employees or agents working regularly in an overseas territory, long running project or contract activity, a fixed office or facility used by the business, and individuals with authority to conclude contracts on the company's behalf. Importantly, PE is not solely a UK domestic law concept. It is defined under the relevant double tax treaty between the UK and the country concerned, and treaty definitions vary significantly.
For businesses with overseas activity, now is the right time to review whether a PE exists, whether it has been correctly identified, and what the mandatory exemption means for their UK tax position going forward.
What you should do now?
- Review all overseas activities - including those of employees, agents, and contractors - to assess whether a PE exists in any jurisdiction, even where one has not previously been identified or disclosed.
- Identify all foreign PEs not currently within the exemption election.
- Review unrelieved losses in those PEs and assess their value to your UK tax position.
- Model the effective tax rate impact of losing that offset.
- Review whether branch versus subsidiary remains the right structure for overseas operations.
- Seek advice early to manage transitional risks and opportunities
We’re here to help
This reform represents a fundamental shift in how overseas branch activity is treated for UK tax purposes, with both structural and compliance implications.
If you would like to discuss how your business may be affected - or require support in reviewing your overseas operations - please get in touch with a member of our Corporate Tax team or speak to your usual Azets adviser.
