 Branch profits exemption
UK companies are now able to make an election to exempt their overseas branches from taxation. Once the election has been made, it will be irrevocable (although it can be revoked at any time before the first accounting period to which it would have effect) and will apply to all of the company's overseas branches for all accounting periods following the one in which the election is made.
The exemption is available to all large and medium-sized companies. It does not apply, however, to small companies, unless there is a 'full treaty' between the UK and the territory in which the company's branch is based. A 'full treaty' is one which includes a non-discrimination article.
Once the election is made, profits arising in all of the company’s current and future overseas branches will be permanently exempt from UK corporation tax. Should any of the branches make losses however, those losses will not be available to off-set against the company’s profits. Companies will therefore need to consider carefully whether its branches are likely to make profits or losses in the future before deciding whether to make the election.
Where a company’s branches suffered losses in any of the six years prior to the exemption coming into force, profits will become exempt once the tax losses of those branches in the immediately preceding six years have been matched by profits. There are special rules for very large losses (those over £50m) incurred in accounting periods beginning on or after 19 July 2005. The default position is that all the branches looking backwards and going forwards are considered in aggregate when working out whether past losses have been matched with subsequent profits. However, it is possible to elect for the branches in specified territories to be streamed so that, for example, once all the losses previously incurred in that territory have been matched with profits from the same territory, any future profits from that territory will be exempt.
The exemption will apply to the trading profits of the branch, as well as investment income effectively connected to the branch and chargeable gains arising from the disposal of assets used by the branch. Trading profits and chargeable gains are defined with reference to the relevant double tax treaty. For branches in territories that have no tax treaty with the UK, the measure of exempt profits will be determined with reference to the OECD model treaty as released in July 2010.
Anti-avoidance measures have been introduced, along similar lines to the CFC rules, to prevent the diversion of profits for tax avoidance purposes. Motive, lower level of taxation and de minimis level of profit tests have been included to prevent some branches from falling foul of these anti-avoidance rules. When the CFC rules are amended in Finance Act 2012, the anti-avoidance rules applicable to the branch exemption will be re-written so that the same broad rules continue to apply to both subsidiaries and branches of UK companies.
The branch exemption does not extend to international air transport and shipping as these activities are generally not taxable in the foreign jurisdiction under the relevant treaty and the OECD model.
Some companies may find it difficult to decide whether to make the election and whether to use the streaming mechanism referred to above. Once the election is made there is only a limited opportunity to revoke it and so it is important that the right decision is made. We can assist in this decision making process by reviewing past results and forecasted future profits and applying those to the new rules.
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