In May, the government announced a mandatory exemption from UK tax for foreign permanent establishments (PEs) of UK companies. This will replace the current regime, under which foreign PEs are taxable in the UK by default unless a company elects for the exemption.

Draft legislation was published in the summer and has been modified slightly in the Finance Bill that followed the recent Budget.

For UK companies with foreign PEs, this could affect profit attribution, carried-forward losses, capital allowances, tax payments and financial reporting. Companies should start assessing the impact before the rules take effect.

Which companies are affected, and when?

The changes will mainly affect UK-resident companies with one or more foreign PEs that have not already elected for exemption. Companies that have already elected for exemption could also be affected if the election is not yet fully effective. This is due to the transitional rules that apply where the PE has made losses in the last four years. Such companies will need to assess the impact of changes to the transitional rules.

The mandatory exemption applies for accounting periods beginning on or after 1 January 2027. The government has decided not to proceed with an earlier start date for certain oil and gas companies, a welcome simplification to earlier proposals. However, anti-forestalling rules ensure that companies cannot manipulate their accounting date to delay the date from which mandatory exemption takes effect.

Affected companies should therefore plan on the basis that mandatory exemption will apply from their first accounting period beginning on or after 1 January 2027.

What should companies do?

Identify PEs and attribute profits

For the purposes of applying the mandatory exemption, the existence of a PE will be determined by either the relevant double tax treaty or the Organisation for Economic Cooperation and Development (OECD) model treaty. This will normally involve identifying whether there is a fixed place of business or a dependent agent located in the overseas territory.

Determining whether overseas activity creates a PE is not always straightforward, particularly as the global mobility of the workforce increases. Once PEs have been identified, companies should review how profits are attributed to them. The relevant double tax treaty or the OECD model treaty will generally require companies to assess the profits the PE would have earned if it operated as a separate business. Its dealings with the UK head office are treated as taking place on arm’s length terms. This is similar to a transfer pricing exercise on a hypothetical construct.

Ownership of assets under the hypothetical construct also needs to be determined, which may be unclear for mobile assets.

Review capital allowances and losses

Where PEs hold any assets on which capital allowances have previously been claimed, companies should adjust their brought forward capital allowance pools. This is to ensure the tax written down value of those assets is excluded from any future claims. It will not always be easy to determine the relevant tax written down value.

Companies with brought forward losses will need to determine how much of those losses relates to a PE that will now be exempt, as this could restrict future use. The legislation prescribes a seven-step methodology for this exercise, and the results are not always intuitive. Helpfully, the updated provisions in the draft Finance Bill reduce the period of time that companies are required to ‘look back’ when making the assessment, from six years to four.

Consider asset transfers and restrictions to the exemption

Companies should identify any tangible or intangible assets that have been transferred between an overseas PE and head office. These assets could be subject to special tax treatment if they are later disposed of or realised.

The mandatory exemption is not universal and foreign PE profits can still be pulled back into UK tax in some circumstances. Broadly, this will happen where the profits derive from UK land or would be taxable under controlled foreign company (CFC) rules. This targets profits artificially diverted from the UK. Companies should therefore consider whether any of their PEs are affected by this restriction to the exemption.

Assess the impact on other tax regimes

Companies should also consider how the mandatory exemption interacts with other tax regimes. This includes assessing the impact on:

• UK R&D and patent box claims, which could be reduced where the foreign PE undertakes or has undertaken R&D activities
• Pillar Two calculations, with top up taxes potentially more likely if there are profitable PEs in low tax jurisdictions
• Hybrid mismatches and corporate interest restriction analysis.

What does this mean for tax payments?

Given that the rules apply for accounting periods beginning on or after 1 January 2027, they could impact tax payments that fall due quite soon. Those affected will need to consider the impact of the provisions when determining how much to pay.

For example, a company with a 31 December year end and very large profits will make its first payment for an affected period on 14 March 2027. Should the Finance Bill not be enacted by that date, special rules will apply for the purposes of calculating interest on under- or over-payments.

How will the changes affect financial statements?

The mandatory exemption could affect current tax calculations for periods after it takes effect. It could also affect the recognition and measurement of deferred tax assets and liabilities. In particular, the adjustments outlined above in relation to capital allowances and carried forward losses will be relevant to deferred tax.

The legislative process complicates the position. IFRS and UK GAAP require legislation to be substantively enacted by the reporting date for changes to be reflected in deferred tax provisions. In this case, that means passing its third reading in the House of Commons. US GAAP requires the legislation to be enacted, which means receiving Royal Assent.

Using prior years’ timetables as a guide, the Finance Bill is unlikely to be substantively enacted or enacted before spring 2027. Companies with December financial year ends are therefore unlikely to need to reflect the changes in their 2026 deferred tax provisions. Where their impact would be material to a user of the financial statements, companies should disclose the nature of the change and potentially an estimate of the amount.

The position could be different for a company drawing up accounts to 30 June each year – the Finance Bill is much more likely to be enacted by 30 June 2027. It is therefore likely that the mandatory PE exemption should be reflected in the 2027 deferred tax provision.

When should action be taken?

For UK-resident companies with a 31 December year end that have not previously elected to exempt their foreign PEs, the key actions are:

• Identify all foreign PEs
• Ensure appropriate profit attribution methodologies are applied to foreign PEs
• Calculate the tax written down value for capital allowances purposes of any assets held by foreign PEs as at 31 December 2026
• Calculate the extent to which any losses carried forward as at 31 December 2026 are attributable to foreign PEs, using the methodology outlined in the legislation
• Identify any tangible or intangible assets transferred between head office and an overseas PE
• Identify any PEs with interests in UK land or which could be taxable under CFC rules
• Consider the impact on specific tax regimes.

For these companies, the first tax return to be affected will be the one for the 2027 financial year. However, companies should not wait until their first 2027 tax return is due to prepare – the impact should be considered as part of the 2026 compliance cycle.

This will help determine what needs to be reflected in the company’s 2026 statutory accounts and inform the assessment of corporation tax payments falling due in 2027.

If your company has, or may have, a foreign PE and you would like to discuss the impact of mandatory exemption in more detail, please contact Shannon Dowdles or your usual RSM contact.

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