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HMRC internal manual

International Manual

Foreign banks trading in the UK through permanent establishments: Attribution of profits to a permanent establishment

The determination of the profits attributable to a permanent establishment is governed by CTA09/S19 and S20. For further detail see INTM267030.

CTA09/S21(2) specifies that a PE shall be assumed to have:

  • the same credit rating as the non-resident company, and
  • such equity and loan capital as it could reasonably be expected to have at arm’s length

As a result of these assumptions, the interest and other funding costs of the PE are calculated so that the PE only obtains a tax deduction for an arm’s length amount of those costs. Detailed guidance on the practical impact of this legislation and on how to attribute capital to bank permanent establishments is set out at INTM267700 onwards.

There are also supplementary provisions at CTA09/S26 and S27 which have specific application to non-resident banks and deal with

  • transfers of loans and other financial assets
  • attribution of financial assets

These provisions are treated in more detail at INTM267623 and INTM267624 respectively.

Accounting periods beginning before 1 January 2003

Prior to the introduction of new measures in FA03 non-residents that traded in the UK were brought within the charge to Corporation Tax by ICTA88/S11 (see INTM262030 regarding the charge to Income Tax.). This section provided that a non-resident company would not be within the charge to UK corporation tax unless it carried on a trade through a branch or agency, but if it did so, it would be chargeable on all of its chargeable profits wherever arising.

This could be read as a very wide ranging provision and there was little else in UK domestic law to indicate how the chargeable profits of the branch or agency should be computed.

In practice, where the non-resident was based in a country with which the UK had a double taxation agreement, profits were attributed to the permanent establishment (PE) in a way that was consistent with the relevant business profits article (Article 7 in the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention) and with the OECD Model Commentary and other relevant OECD publications, such as ‘Transfer Pricing and Multinational Enterprises: Three Taxation Issues’. It is accepted that Article 7 did not result in the application of capital attribution rules.

Before FA03, capital was not generally regarded as attributable to a UK PE because even though the language of Article 7 of the OECD Model Tax Convention is wide enough to allow the attribution of capital there was no specific provision in UK domestic law. In other words, although a treaty reflecting the language in Article 7 gave the UK sufficient taxing rights to permit the attribution of capital, there was no domestic law taking up those taxing rights.

Thus, whilst free working capital adjustments were made in certain limited circumstances such as where funds were provided to the PE to acquire premises or other fixed assets or where funds were provided as initial working capital, the operations of a PE could be almost wholly funded by debt, even though the bank itself would have equity capital and some of this would be supporting the assets and risks of the UK PE.