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HMRC internal manual

International Manual

From
HM Revenue & Customs
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UK residents with foreign income or gains: income arising abroad: Branch profits

A UK enterprise trading abroad may carry on the trade through a branch which is a permanent establishment in the foreign country. The foreign country is entitled to tax the profits of the UK enterprise attributable to that branch in accordance with the business profits Article of the agreement (see INTM153080).

Under the standard elimination of double taxation Article in UK treaties, the UK is obliged to give credit for foreign tax payable on profits, income or chargeable gains from sources within the other state against any UK tax computed by reference to the same profits, income or chargeable gains by reference to which the foreign tax is computed.

HMRC gives credit relief for the lesser of the foreign tax and the UK tax on the branch profits. But is this limiting factor the UK tax on the foreign tax measure of the branch, or the UK tax on the foreign commercial measure of the branch profits or the UK tax on the UK tax measure of the branch profits?

Following the cases of George Wimpey International Ltd v Rolfe, 62 TC 597 and Yates v CGA International Ltd, 64 TC 37, one must look to UK law when determining the amount of the overseas income that will be taxed in the UK. Credit relief will be due for the lesser of the foreign tax and the UK tax computed by reference to the UK tax measure of the foreign source income, not the notional UK tax based on either the foreign tax measure or the foreign commercial measure.

In considering tax credit relief in these cases, there are three steps to be taken in matching these foreign branch profits with the UK measure of those profits. The following example shows these steps. It assumes that the UK enterprise is a company and that all the amounts are expressed in sterling.

  1. Start with the foreign commercial measure of the profits. This will be the profit shown by the branch accounts, for example
  £   £
       
Expenses 900 Earnings 1,000
Depreciation 20    
Profit 80    
  1,000   1,000
  1. Get the foreign tax calculation
  £
   
Profit 80
Disallowable expenses 100
Depreciation 20
  200
Less foreign capital allowances 50
Foreign tax measure of the profits 150
Foreign tax at, say, 40% 60

It is not normally necessary to explore the precise details of the computations of the foreign taxable profits. It is sufficient to be satisfied that the foreign tax is a tax on profits and represents the minimum tax bill. However, it may be worth while checking that the company has correctly allocated all appropriate costs to the foreign branch in accordance with the business profits Article of the relevant agreement. Failure to do so would lead to overstatement of the foreign branch profits and to the payment of an excessive amount of foreign tax. See also INTM163050.

  1. Work out the UK tax payable on the profits of the branch
  £
   
Profit 80
Disallowable expenses under UK law 120
Depreciation 20
  220
Less UK capital allowances 120
UK tax measure of the profits 100

The UK Corporation Tax attributable to the branch profits is £30 and this is the limit of credit (see INTM167060 onwards) for this year. For APs beginning on or after 21 March 2000 excess foreign tax may be carried forward or back.

If the UK enterprise had been carried on by an individual, profits of £100 would be included in the computation set out at TIOPA10/S36(2)(a) as “total income” and then deducted for the computation set out at TIOPA10/S36(2)(b) as “income in respect of which credit is to be allowed”(see INTM165030 onwards).

In the above example the foreign and the UK tax measures of the profits for the same period differ because of different rules in the two countries about admissible expenses and capital allowances. Differences can also result from different rules about the allowance and writing back of provisions and reserves, including timing differences. The approach is that, notwithstanding such differences, the foreign tax on the foreign tax measure of the branch profits for a particular period is credited against, and up to the amount of, the UK tax on the UK tax measure of the profits for the same period.

There may be practical difficulties in identifying precisely the UK measure of taxable profits, for example the pooling regime for plant and machinery allowances makes it difficult to ascertain what allowances are due against branch profits. Reasonable methods of apportionment may be accepted.

In the past (up to the early 1990s) a different approach was sometimes accepted to the branch profit measure by taking the foreign commercial measure, that is £80 in the example, and applying the appropriate UK tax rate to that figure (£80 at 30 per cent = £24.00). Adoption of the foreign commercial measure approach was only accepted where it was applied consistently. Following the decision in Yates v. GCA International Limited (64TC37) new cases based on the foreign commercial measure should not be accepted, although existing cases should not be disturbed.

Any case where there is difficulty in ascertaining the UK tax attributable to foreign branch profits should be submitted to CTIAA Business International, Outward Investment team.