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HMRC internal manual

International Manual

Foreign Permanent Establishments of UK Companies: exclusions and definitions: Investment Business

This applies for relevant accounting periods beginning on or after 1 January 2013.

CTA09/S18CB: Profits and losses from Investment Business

For relevant accounting periods beginning on or after 1 January 2013, profits or losses from investment Business are to be excluded from the relevant amount (referred to in the legislation as the relevant profits or relevant losses amount). This broad rule prevents profits or losses from investment business from qualifying under the foreign permanent establishment exemption.

However this general prohibition in relation to investment profits and losses is relaxed to a minor extent by CTA09/Part 2/CH3A/S18CB(2) which allows investment profits and losses to qualify for exemption, to the extent that they arise from assets that are effectively connected to a part of the permanent establishment through which a trade or overseas property business is carried on.

This exemption to the general rule at S18CB(2) is designed to deal with incidental amounts of investment income that arise in connection with a trade or overseas property business. The term “effectively connected” takes the same meaning as used in the OECD model. However, it is important to note that whilst the OECD commentary refers to assets being effectively connected to a permanent establishment, S18CB(2) is more restrictive. It is not sufficient that the assets which give rise to the investment profits or losses are effectively connected to the permanent establishment. The additional condition - that the assets have to be effectively connected to a part of the permanent establishment through which a trade or overseas property business is carried on - is intended to ensure that only such investment income which is ancillary to or arises as a result of a trade or overseas property business can fall within the foreign permanent establishment exemption rules.

Example 1

A UK company has a foreign permanent establishment through which it carries on a retail trade with third parties.

That retail trade generates significant profits, and those profits are paid up as dividends by the UK company to its parent on an annual basis.

To the extent that those profits are held by the foreign permanent establishment, and they generate investment income, then those profits would normally be considered to be effectively connected to the trade carried on by the permanent establishment. Such profits would therefore meet the condition of S18CB(2), which overrides the general prohibition on investment income imposed by S18CB. It follows then any such investment income would still be within the exempt relevant profits amount for that permanent establishment.

Example 2

As in example 1, a UK company has a foreign permanent establishment through which it carries on a retail trade with third parties.

As in example 1, the profits of that retail trade are paid up as dividends by the UK company on an annual basis. Any investment income arising from those profits prior to dividends being paid up would fall within S18CB(2) as above.

However, if the UK company also chose to hold long term group investments through that foreign permanent establishment, the profits arising from that separate investment activity would not fall within S18CB(2), and so would be excluded from the exempt relevant profits amount by virtue of S18CB. Although such investment assets could be considered to be “effectively connected” with the permanent establishment, they would not be effectively connected to that part of the permanent establishment through which the trade was carried on.