On 21 May 2026, HMRC published a policy paper announcing a fundamental shift from an elective to a mandatory exemption regime for Foreign Permanent Establishments (FPEs), with potentially far-reaching consequences for UK headed multinational groups.
Draft legislation is not expected until later this year, but the direction of travel is clear: the Government intends to remove the long-standing previously elective treatment allowed in the UK corporate tax system to create a consistently territorial approach for foreign branch profits.
What will the proposed changes mean for multinationals? Under the current rules, UK resident companies are subject to corporation tax on the profits of their FPEs but may elect to exempt such profits through a foreign branch exemption election. This election applies to all foreign branches of the electing entity, is irrevocable, and means that both profits and losses can be excluded from UK tax.
The proposed reform removes this choice entirely. Instead:
the FPE exemption will become mandatory for all UK resident companies;
FPE profits and losses will be fully excluded from UK corporation tax computations; and
relief for foreign branch losses against UK profits will cease.
The new regime will take effect from 1 September 2026 for companies carrying on oil and gas exploration and extraction activities, reflecting particular policy concerns in that sector. For all other companies, the new regime will take effect from 1 January 2027.
Why change? The Government intends to address situations where multinationals can obtain UK tax relief for overseas losses without paying UK tax on future profits. This asymmetry has been particularly evident in capital intensive sectors, where significant upfront losses and capital allowances can qualify for tax relief in the UK, but later profits either fall outside the UK tax net altogether or where the UK tax due is covered by double tax relief.
The reform represents a shift from a ‘relief now, clawback later’ model, including mechanisms such as the ‘total opening negative amount’, to a more straightforward approach denying relief at the outset.
Key implications for businesses
Loss utilisation and effective tax rate (ETR): The most immediate impact will be the loss of UK tax relief for FPE losses. For groups that have historically set overseas branch losses against UK profits, this will likely result in higher UK taxable profits, increased current tax cost and greater ETR volatility.
Removal of double tax relief: Under the new regime, FPE profits will sit entirely outside the UK tax net, removing the need for double tax relief. This simplifies UK tax computations, but it also removes a mechanism that has historically smoothed differences in tax rates across jurisdictions.
Impact on oil and gas businesses: The accelerated implementation for oil and gas groups highlights the Government’s concern that the existing regime has allowed significant UK tax relief for exploration and development losses, often supported by substantial capital allowances. Under the new rules, that relief will no longer be available in the UK, and UK group trading profits will no longer be reduced by overseas losses.
Structural considerations: by removing the tax distinction between an elected and non-elected branch, the reform will change the analysis for ‘branch versus subsidiary’ structuring decisions. Key considerations will now need to include: interaction with transfer pricing and profit attribution rules; local tax regime characteristics, including withholding taxes and reliefs; and exposure to Controlled Foreign Company (CFC) rules where activities are moved into subsidiaries.
How the new rules interact with other tax regimes: Although the policy paper is high-level, there are a number of knock on effects likely to arise.
Overseas R&D costs arising in a non-exempt foreign branch will no longer be within the scope of UK corporation tax, and therefore, this expenditure may not qualify under the UK’s R&D regimes
CFC and anti diversion rules may become more prominent as profits fall outside the UK tax net
Pillar Two (global minimum tax) outcomes could change materially, with potential for increased top up tax where UK tax no longer contributes to jurisdictional ETRs
Transfer pricing considerations will remain critical, as HMRC is likely to pay more attention to branch profit attribution.
How will the rules be phased in? The detail of the transitional rules will be critical. The Government has already indicated that measures will be introduced to restrict the use of historic FPE losses following implementation and prevent arrangements designed to accelerate loss utilisation ahead of the change.
At this stage, the proposals are set out in a policy paper only, with draft legislation expected over the summer of 2026. Nonetheless, the scale of the change means that affected groups should begin preparations now.
This reform is one of the most significant changes to the UK’s international tax framework in recent years. By removing the ability to obtain UK relief for foreign branch losses, the Government is resetting the balance between competitiveness and protecting the domestic tax base.
For multinationals, early engagement and detailed modelling will be essential to navigate the transition effectively.
Home >Articles > Foreign PE exemption becoming mandatory
Foreign PE exemption becoming mandatory
A shift to denying relief at the outset.
On 21 May 2026, HMRC published a policy paper announcing a fundamental shift from an elective to a mandatory exemption regime for Foreign Permanent Establishments (FPEs), with potentially far-reaching consequences for UK headed multinational groups.
Draft legislation is not expected until later this year, but the direction of travel is clear: the Government intends to remove the long-standing previously elective treatment allowed in the UK corporate tax system to create a consistently territorial approach for foreign branch profits.
What will the proposed changes mean for multinationals? Under the current rules, UK resident companies are subject to corporation tax on the profits of their FPEs but may elect to exempt such profits through a foreign branch exemption election. This election applies to all foreign branches of the electing entity, is irrevocable, and means that both profits and losses can be excluded from UK tax.
The proposed reform removes this choice entirely. Instead:
the FPE exemption will become mandatory for all UK resident companies;
FPE profits and losses will be fully excluded from UK corporation tax computations; and
relief for foreign branch losses against UK profits will cease.
The new regime will take effect from 1 September 2026 for companies carrying on oil and gas exploration and extraction activities, reflecting particular policy concerns in that sector. For all other companies, the new regime will take effect from 1 January 2027.
Why change? The Government intends to address situations where multinationals can obtain UK tax relief for overseas losses without paying UK tax on future profits. This asymmetry has been particularly evident in capital intensive sectors, where significant upfront losses and capital allowances can qualify for tax relief in the UK, but later profits either fall outside the UK tax net altogether or where the UK tax due is covered by double tax relief.
The reform represents a shift from a ‘relief now, clawback later’ model, including mechanisms such as the ‘total opening negative amount’, to a more straightforward approach denying relief at the outset.
Key implications for businesses
Loss utilisation and effective tax rate (ETR): The most immediate impact will be the loss of UK tax relief for FPE losses. For groups that have historically set overseas branch losses against UK profits, this will likely result in higher UK taxable profits, increased current tax cost and greater ETR volatility.
Removal of double tax relief: Under the new regime, FPE profits will sit entirely outside the UK tax net, removing the need for double tax relief. This simplifies UK tax computations, but it also removes a mechanism that has historically smoothed differences in tax rates across jurisdictions.
Impact on oil and gas businesses: The accelerated implementation for oil and gas groups highlights the Government’s concern that the existing regime has allowed significant UK tax relief for exploration and development losses, often supported by substantial capital allowances. Under the new rules, that relief will no longer be available in the UK, and UK group trading profits will no longer be reduced by overseas losses.
Structural considerations: by removing the tax distinction between an elected and non-elected branch, the reform will change the analysis for ‘branch versus subsidiary’ structuring decisions. Key considerations will now need to include: interaction with transfer pricing and profit attribution rules; local tax regime characteristics, including withholding taxes and reliefs; and exposure to Controlled Foreign Company (CFC) rules where activities are moved into subsidiaries.
How the new rules interact with other tax regimes: Although the policy paper is high-level, there are a number of knock on effects likely to arise.
Overseas R&D costs arising in a non-exempt foreign branch will no longer be within the scope of UK corporation tax, and therefore, this expenditure may not qualify under the UK’s R&D regimes
CFC and anti diversion rules may become more prominent as profits fall outside the UK tax net
Pillar Two (global minimum tax) outcomes could change materially, with potential for increased top up tax where UK tax no longer contributes to jurisdictional ETRs
Transfer pricing considerations will remain critical, as HMRC is likely to pay more attention to branch profit attribution.
How will the rules be phased in? The detail of the transitional rules will be critical. The Government has already indicated that measures will be introduced to restrict the use of historic FPE losses following implementation and prevent arrangements designed to accelerate loss utilisation ahead of the change.
At this stage, the proposals are set out in a policy paper only, with draft legislation expected over the summer of 2026. Nonetheless, the scale of the change means that affected groups should begin preparations now.
This reform is one of the most significant changes to the UK’s international tax framework in recent years. By removing the ability to obtain UK relief for foreign branch losses, the Government is resetting the balance between competitiveness and protecting the domestic tax base.
For multinationals, early engagement and detailed modelling will be essential to navigate the transition effectively.
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