The UK government’s draft legislation would make the foreign permanent establishment exemption mandatory for UK-resident companies from 2027, introduce a new international test for permanent establishment status, and impose transitional rules for certain carried-forward losses and capital allowances.
The UK government has published draft legislation proposing to make the foreign permanent establishment (PE) exemption compulsory for UK-resident companies from 1 January 2027.
The draft legislation, published on 13 July 2026, would amend Part 2 of the Corporation Tax Act 2009 (CTA 2009), including Chapter 3A, which covers profits of foreign permanent establishments.
The proposed reforms would replace the current election-based system with a mandatory exemption regime and introduce a new international meaning of “permanent establishment” for the purposes of the exemption. The legislation also contains transitional rules for certain carried-forward income and capital losses and capital allowances, anti-avoidance provisions, specific commencement rules for short accounting periods, and consequential amendments across the UK tax legislation.
Foreign PE exemption to become compulsory
Under the proposed changes, companies would no longer be able to elect whether the foreign PE exemption applies.
Instead, section 18A of CTA 2009 would provide that exemption adjustments are to be made when calculating a company’s taxable total profits for an accounting period.
The draft legislation would also repeal section 18F, which currently deals with the effect of an election, as well as sections 18J to 18O concerning companies with a total opening negative amount.
New international definition of permanent establishment
The legislation would introduce new section 18RA into CTA 2009, establishing an international meaning of “permanent establishment” specifically for the foreign branch exemption.
For companies operating in a “full treaty territory”, whether the business is carried on through a permanent establishment would be determined under the applicable double taxation arrangements.
For other territories, the test would be based on the OECD model.
This would replace the general approach under Chapter 2 of Part 24 of CTA 2010 for determining eligibility for the foreign PE exemption.
The draft would also amend section 1140A of CTA 2010 to clarify that the general permanent establishment provisions are subject to new section 18RA when determining whether the foreign PE exemption applies.
Transitional rules for carried-forward losses
The proposed legislation includes transitional provisions addressing losses and capital allowances arising from the move to a compulsory exemption.
Schedule 2 would restrict the ability of certain companies to carry forward income losses arising from foreign permanent establishments before the new rules take effect. Similar provisions would apply to carried-forward capital losses, while separate rules would address capital allowances.
Income losses
The restrictions on carried-forward income losses would apply where a company:
- operated through a foreign PE during the relevant lookback period;
- had at least one accounting period during that period in which a section 18A election did not apply; and
- held carried-forward income losses in its first post-commencement accounting period.
The draft sets out a calculation to determine the amount of losses subject to restriction. This involves considering the company’s aggregate carried-forward income losses and comparing foreign PE and head-office amounts during the lookback period.
The lookback period covers accounting periods ending less than six years before the start of the first post-commencement accounting period.
Restricted income losses would generally not be available for set-off against profits in a post-commencement accounting period. However, the draft provides limited circumstances in which the losses could be set against relevant foreign PE profits, including profits connected with UK land or property businesses and diverted profits.
Capital losses
Similar rules would restrict certain carried-forward capital losses.
The draft provides for a calculation based on head-office and foreign PE amounts, with the restricted amount representing the portion of carried-forward capital losses allocated to a net foreign PE amount.
Restricted capital losses could still be deducted in limited circumstances where chargeable gains reflect profits connected with interests in UK land that are not excluded under the foreign PE exemption rules.
Anti-avoidance rules
The draft legislation also contains a specific anti-avoidance provision targeting arrangements designed to obtain a tax advantage from the transition to the new regime.
A tax advantage arising from “foreign-PE-related avoidance arrangements” would be counteracted through adjustments that are just and reasonable, provided specified timing, purpose and abuse conditions are met.
The timing condition would cover arrangements entered into on or after 13 July 2026. It would also cover arrangements established on a contingent or preparatory basis before that date where they are committed to, confirmed or formalised on or after 13 July 2026.
The purpose condition would apply to arrangements intended to obtain a tax advantage by moving income, expenditure, profits or losses between pre-commencement and post-commencement accounting periods. It would also cover arrangements intended to secure a tax advantage from the operation of the new rules.
An abuse condition would additionally need to be satisfied. This would apply where it is reasonable to regard arrangements as circumventing the intended commencement or operation of the legislation or exploiting shortcomings in the new provisions.
The draft specifically refers to steps that are contrived or abnormal or lack a genuine commercial purpose.
HMRC would be able to counteract a relevant tax advantage through an assessment, modification of an assessment, amendment or disallowance of a claim, or another adjustment.
Commencement from 2027
The main provisions, including sections 1 to 4 and Schedules 1 and 2, would apply to accounting periods beginning on or after 1 January 2027.
The anti-avoidance provision in section 5 would apply to accounting periods ending on or after 13 July 2026.
Separate commencement rules would apply to companies with accounting periods of less than 12 months ending on or after 13 July 2026 but before 1 January 2027.
For these companies, the new provisions would generally take effect from the relevant anniversary of the start of the earliest relevant short accounting period. The draft provides for either the first or second anniversary, depending on when that short accounting period began.
Where an accounting period straddles the relevant anniversary, it would be treated as two separate accounting periods. Profits would generally be apportioned on a time basis, although a just and reasonable basis could be used where a time-based allocation would be unjust or unreasonable.
Consequential amendments across UK tax legislation
The draft legislation would make consequential amendments to several areas of UK tax legislation, including the Taxation of Chargeable Gains Act 1992 (TCGA 1992), Capital Allowances Act 2001 (CAA 2001), Income Tax Act 2007 (ITA 2007), CTA 2010 and Taxation (International and Other Provisions) Act 2010 (TIOPA 2010).
The changes would cover rules relating to:
- no gain/no loss treatment for foreign permanent establishments;
- capital allowances;
- manufactured dividends and manufactured interest;
- relevant IP profits;
- group mismatch schemes;
- double taxation relief;
- controlled foreign companies; and
- corporate interest restriction.
Transitional treatment for capital allowances and gains
The transitional provisions would also address capital allowances where the compulsory exemption results in a disposal event.
In specified circumstances, the disposal value would be set so that neither a balancing allowance nor a balancing charge arises.
An exception would apply where qualifying expenditure on the relevant plant or machinery exceeds GBP 5 million and the company had used the assets for purposes other than those of a foreign PE during the lookback period.
The draft also contains rules concerning gains in foreign PEs where those gains previously attracted relief. These provisions would determine how certain gains and losses are treated when establishing the first relevant accounting period under the new regime.
