UK and International Tax news
Foreign Branch Exemption
Thursday 20th January 2011
On 9 December 2010 the Government published draft legislation for reforming the taxation of foreign branches. The draft legislation relates to the proposals published on 29 November [see our UK Tax News item of 14 December 2010 on the Finance Bill 2011].
Subsequently on 20 December 2010 the Government published a technical note on this draft legislation, which provides additional information not within the scope of the Explanatory Note, including detail on the relation between the draft legislation and the OECD Model Tax Convention, and matters not covered in the draft legislation. It also includes questions for interested parties. In particular, it covers the basis and territorial scope of the foreign branch exemption, the extension of the exemption to chargeable gains, transitional rules, anti-diversion rules and capital attribution.
The legislation invokes treaty principles to establish the measure of exempt profits. Profits will be exempt to the extent that they are attributed to a permanent establishment (“PE”) in that territory in accordance with the treaty between the UK and that territory. If there is no such treaty, or the treaty lacks a non-discrimination article applicable to the PE, then the OECD Model Convention is referred to instead.
Chargeable gains are also exempt to the extent that gains are attributable to the PE. Article 13(2) of the Model Convention permits the source state to tax gains on moveable property that forms part of the business property of a PE.
Investment income will be included in the exempt profit of the branch to the extent that it is “effectively connected” to that branch. The term “effectively connected” is used in several articles of the OECD Model Convention and where it applies, the income will be taxable in the branch territory in accordance with the Business Profits Article. The income is consequently brought within the scope of draft s.18A(5) CTA2009.
Foreign branch exemption is not currently extended to long term insurance business, comprising life assurance and permanent health insurance. The life insurance tax regime is undergoing extensive changes to bring it in line with new regulatory capital requirements expected for 2013. The Government is to consult closely with industry on potential reform of foreign branch taxation in respect of life insurance companies and on when any such reform would be implemented.
Foreign branch exemption is not extended to the profits and losses of a company whose business is mainly investment business and which derives the principal part of its profits or losses from that business.
Profits of a close company that are derived from chargeable gains will also be excluded from the exemption regime. This is to prevent s.13 TCGA92 from being bypassed through the use of a foreign branch.
Foreign branch exemption will usually not extend to international air transport and shipping as taxation of these activities in the foreign jurisdiction is generally restricted by the relevant treaty article, based on Article 8 of the OECD Model Convention. This prevents the income from being included within the scope of exemption.
The consultation draft proposes to amend the capital attribution rules determining the profits attributable to the foreign PEs of UK companies for the purposes of s.42(2) and the limit on credit relief. The draft legislation provides that the measure of exempt profit or loss in the foreign branch should be based on the Business Profits Article (Article 7) of the relevant treaty, or, if there is no treaty, on the Business Profits Article of the OECD Model Convention published in July 2010. That Model Convention contains a new version of the Business Profits Article which extends the separate enterprise hypothesis further than the article in the old Model Convention, on which all of the UK’s existing treaties that contain that article are largely based. Therefore the measure of exempt profit or loss may differ depending on whether the foreign branch is located in a state with which the UK has a double taxation treaty or not.
There are other matters relating to overseas branches which are not covered in the draft legislation, including a minimisation of branch profits rule, capital allowances, and the corporate intangible regime.
With regard to Manufactured Overseas Dividends (MODs), whilst the draft clauses contain basic provisions treating MODs paid and received by foreign PEs in the same way as those paid by foreign subsidiaries, the Government has asked for views on whether anything further may be required.
HMRC will be reviewing the legislation for avoidance risk, in particular in regard to leasing, and where branch business is transferred between group companies, perhaps following losses incurred in the branch or in anticipation of loss relief.
The Government intends to publish draft legislation as appropriate during the consultation period to supplement the draft Finance Bill Schedule.
If you would like further information on the above, please contact Keith Rushen on 0044 (0)20 7486 2378.
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