Foreign Permanent Establishments of UK Companies: chargeable gains: determining exempt gains or losses
Calculating exemption adjustments
The capital gains article of treaties will generally permit the State in which the permanent establishment is situated to tax gains on the transfer of a movable asset from a PE to another part of the enterprise, provided that such taxation is in accordance with the business profits article.
So if a company transfers an asset from a PE to its head office any gain may be subject to a tax charge in the State of the PE. This is not a disposal for the purpose of corporation tax on chargeable gains because it is a transfer within different parts of the same company. The gain potentially taxable in that State would eventually be included in a “relevant profits amount” for that territory under CTA09/S18A(6) in respect of the period for which it would be taken to be attributable to the PE “for the purpose of ascertaining the amount of any credit to be allowed under TIOPA10”. So, if the company disposes of the asset in a later accounting period, the gain taxable in the other State is taken into account at that point in determining whether and to what extent there is a chargeable gain or allowable loss.
This reflects the treatment for credit relief where credit for the tax suffered on the PE’s gain may be given against the corporation tax arising on a gain on the eventual disposal. Where the eventual disposal follows in a subsequent accounting period there would be no “exemption adjustment” to be made in the accounting period in which the change of economic ownership of the asset within the company took place as there would be no chargeable gain for corporation tax purposes to adjust for. The same considerations arise where the result of a transfer is a loss within CTA09/S18A(7).
CTA09/S18B(1) therefore provides that exemption adjustments include those to remove the effect of any gains and losses taken into account in computing the foreign permanent establishments amount in relation to any accounting period.
Example 1 (ignoring indexation, costs, etc)
An asset is acquired for £50 in 2010 and used exclusively in a PE until 2013 when it is transferred to be used by UK head office. At that time its market value is £200 and the other State taxes a gain of £150. The asset continues to appreciate in value until it is sold to an unconnected company in 2018 for £450. The gain in the corporation tax computation will be £400, but this will be reduced to £250 by the exemption adjustment of £150 in relation to 2013.
In this example the amount of the exemption adjustment is computed using the market value of the asset at the relevant times. However, it is possible that another method may be adopted provided that it gives a reasonable estimate of the result determined by reference to market value. In practice it will often be appropriate to use time apportionment, unless there is reason to believe that there have been significant fluctuations in the value of the asset.
For example it is recognised that where the other State does not tax the gain at the point of transfer or does not tax it according to the market value at that time, it may be difficult or costly to determine market value solely for the purpose of computing the amount of the adjustment. If so an alternative approach in this example, where there have not been fluctuations in the value of the asset, would be to carry out a straight-line apportionment according to the period of ownership.
On that basis, in the example above the asset is held for 8 years and is used exclusively in a PE for 3 years. The gain of £400 is therefore again reduced to a chargeable gain of £250 (5/8 x £400).
Example 2 (ignoring indexation, costs, etc)
Example 1 illustrates the case in which an asset is used exclusively for a PE for part of the period of ownership. An asset may also be used partly for a PE for part or all of the period of ownership. Again the legislation is not prescriptive about how the exemption adjustment should be made. Any method can be used that results in a just and reasonable amount to be exempted.
A property is acquired for £50 in 2010 and 20% of the floor space is used exclusively in a PE, with the rest being rented out to another group company by the UK head office. This continues until 2013 when the PE relocates and the whole property begins to be used by the other group company. The other State does not tax any gain on the cessation of PE use. The asset is sold to an unconnected company in 2018 for £450. The gain in the corporation tax computation will be £400, but this will be reduced to £370 by the exemption adjustment. This is calculated on a time apportionment basis, so that £30 (£400 x 3/8 x 20%) is attributed to the period of PE use.
It will sometimes be the case that an internal transfer reflecting an appreciation of value of the asset is followed by a subsequent disposal at a loss. CTA09/S18B(1) provides that where this occurs a loss may be increased to reflect an earlier gain. This ensures that the overall result is consistent with the analogy of an asset transferred from a foreign subsidiary company and reflects the gain or loss which accrued other than to the PE to which an election under S18A has effect.
Example 3 (ignoring indexation, costs, etc)
If the 2018 disposal of the asset in example 1 above is for £20 the loss without taking account of the exemption adjustment will be £30. On the market value basis of computation this will be increased by an exemption adjustment to £180, which would have been the result if the company had acquired the asset at its market value of £200 in 2013.
If, on the other hand, the market value in 2013 was £30 and the 2018 disposal for £450, the gain of £400 (disposal proceeds £450 less cost £50) in the corporation tax computation would be adjusted for the PE loss of £20 in a computation based on market value to increase it to a chargeable gain of £420.