Mandatory foreign branch exemption: Impact on UK Companies

UK companies operating overseas through branches have enjoyed flexibility in how those activities were taxed in the UK. However, significant changes are now expected following a recent announcement by HMRC. The government is moving towards a more standardised and restrictive regime, removing taxpayer discretion and reshaping the interaction between foreign branch profits, losses, and UK corporation tax.

What is changing in the foreign branch election exemption?

HMRC announced on 21 May 2026 that the foreign branch exemption election will become mandatory for most UK resident companies. The changes are intended to protect the UK tax base from sheltering early-phase overseas losses where later profits are usually not fully subject to UK corporation tax. Additional burden of ensuring appropriate characterisation of overseas activities that could impact both available brought forward losses as well as the go-forward position.

Under the current rules in section 18A of the Corporation Tax Act 2009, a UK resident company may elect into the Foreign Branch Exemption Election regime. Where an election is made, both profits and losses of a foreign branch or permanent establishment are excluded entirely from the calculation of UK taxable profits.

Making the election has historically required careful consideration. Without the election, companies remain subject to UK corporation tax on their worldwide income, including foreign branch profits, although double tax relief is generally available. Where overseas tax rates are lower than the UK corporation tax rate, this can result in an additional UK tax charge, making the election attractive in many cases. However, the election must be made before the start of the relevant accounting period and, once made, is irrevocable, applying to all existing and future foreign branches of the same company.

What is driving the change in approach?

HMRC has identified what it sees as an imbalance in the current rules and is now seeking to address this through a change in law. Where no election is made, companies may use foreign branch losses to shelter UK profits, while the corresponding foreign profits are often never fully taxed in the UK, either because double tax relief removes any residual liability or because once a branch reaches steady profitability, branches are incorporated into subsidiaries and therefore removed from the UK tax net.

In response, the government has announced that the Foreign Branch Exemption Election treatment will become mandatory From 1 January 2027 (or 1 September 2026 for companies undertaking activities in the oil & gas sector), UK companies will no longer have discretion to elect into the regime. Instead, all profits and losses attributable to foreign branches will need to be calculated separately and shall automatically fall outside the UK corporation tax computation.

One consequence is that foreign branch losses will no longer be available to offset against UK profits, which will increase UK tax liabilities for businesses with loss-making overseas operations. Conversely, foreign branch profits will no longer be subject to UK tax, removing the need to rely on double tax relief.

Transitional rules will prevent pre-existing foreign branch losses from being used against UK profits once the new regime takes effect, alongside targeted anti-avoidance measures.

How should UK companies respond?

For UK companies with overseas operations, the obvious impact from these changes is a reassessment of whether the business is best carried on through branches or subsidiaries, considering both tax and wider commercial considerations.

However, less obvious, and perhaps more concerning, is the additional burden of having to assess all overseas activities, including those in prior years where losses were generated and may still be available for future use, to determine the likelihood that those activities gave rise to a permanent establishment as defined under UK domestic law.

Such an analysis may not previously have been undertaken due to the simplicity of being able to tax all company profits in the UK with a claim for foreign tax credit. Equally, where overseas territories tax solely on a source basis or adopt a higher threshold for recognising a permanent establishment, the business activities may not have impacted filing obligations in the overseas territory.

From next year, this will no longer be possible, and a decision will need to be made to either obtain advice on local registration requirements, adopt a more prudent approach to tax-associated profits and disallow losses, or incorporate early. Either way, an assessment of overseas activities and a decision on how to proceed going forward is required.

If you have any questions about establishing foreign branches and making the relevant elections, please do not hesitate to get in contact with Ruth MacNamee, Greg Smythe or your usual AAB contact.