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HMRC internal manual

International Manual

HM Revenue & Customs
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The attribution of capital to foreign banking permanent establishments in the UK: Legislative approach

The legislation at CTA09/Part 2/Chapter 4 aims to recognise for UK tax purposes the commercial reality that a bank’s business must be supported by an appropriate amount of capital and that this has a direct effect on the overall profitability of the business.

It sets out the basis on which the profits attributable to an UK permanent establishment (PE) of a non-resident company are to be determined. In particular, CTA09/S21(1) provides that the profits to be attributed are those that the PE would make if it were:

  • a separate entity in the UK,
  • engaged in the same or similar activities,
  • under the same or similar conditions, and
  • dealing wholly independently of the non-resident company.

In arriving at those profits, certain assumptions are required to be made:

  1. It is put beyond doubt that the PE is to be dealt with on the basis that it has the same credit rating as the company as a whole
  2. The PE has the equity and loan capital that it would have if it were a separate entity carrying out those activities, under those conditions.

The section goes on to prohibit deductions in arriving at profits chargeable to corporation tax in excess of those which would have arisen on those assumptions.

For the reasons outlined in INTM267701, there are regulatory requirements for banks as to the amount of capital required; they reflect the economic reality of the business. In general terms, a UK bank engaged largely in ‘risky’ lending to commercial concerns would be required to hold more capital than one which lends primarily to Organisation for Economic Co-operation and Development governments. Its returns are likely to be correspondingly higher reflecting that additional risk and capital. The legislation recognises such economic reality and replaces the current arbitrary free working capital adjustment, which may bear no relation to the UK PE’s business.

The new legislation does not require the actual allotment of capital to the UK PE. This remains, as now, a matter for the bank itself. But where there has in fact been a capital allotment based on the economic and regulatory requirements of the PE’s business, any tax adjustment under the new legislation is likely to be relatively minor, taking into account that allotment.

Where, however, the UK PE’s business is not supported, or is inadequately supported, by capital, the purpose of the legislation is to make an adjustment to the UK tax computation to align the taxable profits more closely with those which would be achieved by similar banking activities carried out by a UK bank in the same or similar circumstances.

To avoid confusion, this tax adjustment is referred to as the capital attribution tax adjustment. The term free working capital adjustment refers only to adjustments made prior to the application of the new legislation.