An election to fall within the new branch exemption regime can be made at any time after Royal Assent. The election applies to all accounting periods following that in which it is made although previous losses can delay entry into the regime.
The exempt amounts include chargeable gains and take account of capital allowances. There is an anti-diversion rule which prevents the exemption from applying unless a motive test is satisfied. There are various other exclusions from the regime including chargeable gains realised by the branch of a close company.
This article is intended to be a short overview of the new branch exemption regime contained in Schedule 13 of the current Finance Bill.
As with the changes made to the taxation of foreign dividends in 2009, the new regime replaces the current ‘tax with credit’ system with a simpler exemption system.
As such, the new rules are likely to be welcomed by the business community and particularly by those companies (such as banks) which tend to carry on their trades through foreign branches instead of foreign subsidiaries.
Making the election
An election to fall within the new regime can be made at any time after Royal Assent.
Once a company has made an election, the election will apply to all accounting periods of the relevant company following that in which it is made, although there are provisions (discussed below) which can delay entry into the regime in cases where the company has made losses in its foreign branches.
The election is revocable but only until the start of the first accounting period for which the election would otherwise have effect.
The scope of the election
For an accounting period in which the election applies, the taxable profits of the relevant company are required to be calculated on the basis that they do not include the ‘foreign permanent establishments amount’.
This is defined as the aggregate of the ‘relevant profits amount’ in the case of each foreign territory less the aggregate of the ‘relevant losses amount’ in the case of each foreign territory.
The ‘relevant profits amount’ is defined by reference to the profits which would be taken to be attributable to the branch for the purpose of ascertaining the amount of any credit in the UK under TIOPA 2010 (in the case of a full treaty territory) or the profits which would be taken to be so attributable if the territory in which the branch is located had a treaty with the UK following the OECD Model (in any other case).
The legislation provides that the basis on which the relevant foreign territory imposes tax on the permanent establishment will not determine the scope of the exemption.
It also stipulates that, even if a particular treaty does not provide for credit to be calculated by reference to the profits attributable to the permanent establishment, it will be assumed to do so.
Thus, the scope of the exemption in each case simply turns on the measure of the profits attributable to the branch in question.
The ‘relevant losses amount’ is defined by reference to the same rules and principles as are applicable to the calculation of the ‘relevant profits amount’.
Chargeable gains
The exempt amount calculated as described above includes chargeable gains or allowable losses realised on assets held by the branch.
However, in cases where the entire chargeable gain or allowable loss arising in respect of a capital asset does not fall within the scope of the exemption – for example, because the asset has not been held by the relevant branch for the entire period in which the asset has been held by the company in question – an adjustment is required in order fairly to reflect the profit or loss attributable to the foreign branch.
Thus, in circumstances where an asset which has been acquired for 100 is transferred to the branch at a time when it has accreted in value to 200 and is then sold out of the branch for 150 (so there is a loss attributable to the branch of 50), the chargeable gain (ignoring indexation) of 50 will be increased to 100.
The legislation also provides that gains and losses arising on immovable property in a foreign territory which has been used for the purposes of the branch in that territory are to be included in the branch profits or losses even if they would not otherwise have formed part of the profits attributable to the branch for the purpose of ascertaining the amount of any credit in the UK under TIOPA 2010.
In some cases, a gain on an asset will fall to be taken into account in calculating the branch profits or losses in an accounting period prior to the accounting period in which the company realises a profit on the asset for UK tax purposes.
In order to prevent a company from benefiting from the branch exemption in respect of any gain that is taken into account in calculating branch profits or losses arising in accounting periods falling before the election takes effect, the legislation excludes such gains from the scope of the exemption.
Capital allowances
From the capital allowances perspective, notional allowances or charges are required to be taken into account in calculating the ‘relevant profits amount’ and the ‘relevant losses amount’. Effectively, each asset is treated as being transferred to the branch at its tax-written down value for the purposes of calculating future notional allowances and charges.
Exclusions from the election
Even if an election is made, certain branch profits will be excluded from the ambit of the election.
For instance, the election does not apply to the branch profits of a ‘small company’ unless the branch in question is located in a full treaty territory.
In addition, chargeable gains realised by a branch of a close company are precluded from qualifying for the exemption. This makes sense as a policy matter, given that TCGA 1992 s 13 imputes to the shareholders of a non-UK resident close company the chargeable gains made by that company.
The exemption also does not extend to profits or losses arising to a branch as lessor under a plant or machinery lease where the company in question or a company connected with it have benefited from capital allowances in respect of expenditure on the provision of the plant or machinery in question.
Finally, branch profits arising from basic life assurance and general annuity business (as defined in ICTA 1988 ss 431(2)) do not qualify for the exemption and there are various other special rules which apply in this context to insurance companies.
The exemption also does not extend to profits or losses referable to a transaction into which a branch has entered with a UK resident in circumstances where the UK resident in question would have been obliged to withhold tax from any payments under the transaction had it been making those payments to a company resident in the territory in which the branch is located and no refund of that withholding tax would have been available to the non-UK resident company under the applicable treaty.
The branches of banks are excluded from this provision except in relation to transactions forming part of arrangements which have, as one of their main purposes, the avoidance of withholding tax.
Anti-diversion rule
There is an anti-diversion rule which prevents the exemption from applying to the income profits of a branch located in a territory where the amount of tax paid is less than 75% of the amount of corporation tax that would have been paid on the income profits of the branch. This replicates the equivalent test in the CFC rules.
As with the CFC rules, it is possible to escape the anti-diversion rule by relying on a two-limbed motive test.
Provision is made for a partial application of the exemption in circumstances where the relevant company fails the motive test only because, as regards one or more transactions the results of at least one of which is reflected in the profits attributable to the branch, it is one of the main purposes of that transaction to achieve a reduction in UK tax which was not minimal.
In those circumstances, the exemption still applies but a just and reasonable adjustment is made to the exempt amount to exclude from the exemption the effects of the transaction or transactions which had the reduction in UK tax as one of its or their main purposes.
Deferral
Provision is made for the application of the new regime to be deferred in circumstances where there is a total opening negative amount at the beginning of the first accounting period for which the election would otherwise have had effect.
In order to calculate whether a total opening negative amount exists, the company needs to calculate what the ‘foreign permanent establishments amount’ would have been in each of the accounting period in which it makes the election and any earlier accounting period ending less than six years before the end of that accounting period (an ‘affected period’) assuming that chargeable gains or allowable losses were excluded from that calculation (the ‘adjusted amount’).
If this calculation reveals that the ‘adjusted amount’ is a loss in any ‘affected period’, the company needs to go back to the earliest ‘affected period’ in which a loss is calculated and then add the ‘adjusted amount’ in each subsequent ‘affected period’ to that amount but not so as to cause the result to exceed nil. There will be a total opening negative amount in the case of the company if the result of that calculation results in a negative amount.
This rule generally applies on a global basis but provision is made for ‘streaming’, pursuant to which losses arising in a particular territory or territories can be streamed against profits arising in the same territory or territories, with the general rule applying only to the residue.
These rules are extended in cases where a large loss of over £50 million has been made in any foreign branch in an accounting period beginning in the six years preceding the date of Royal Assent.
In that case, that accounting period and each subsequent accounting period of the company is deemed to be an ‘affected period’ for the purposes of the above calculation.
Tony Beare, Tax Partner, Slaughter and May
