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HMRC internal manual

International Manual

Profits attributable to a permanent establishment of a UK resident company - TIOPA10/S43: approach to capital attribution in the host state

Approach in the PE host state

The assumption of S43(3)(b) is that the PE has such equity and loan capital as it would reasonably be expected to have if the equity and loan capital of the company were allocated between the company’s foreign PEs and the rest of the company’s business. TIOPA10/S43(5) provides that this is subject to the terms of the UK’s double taxation convention with the PE’s host country if it is a “full treaty territory”. The meaning of full treaty territory is given by CTA09/S18R within Chapter 3A, which provides for branch exemption (see INTM287060).

S43(5) therefore makes it clear that S43(3)(b) does not have the effect of limiting the attribution of profits to the PE to a lower measure than that which the other state taxes in accordance with the business profits article of the relevant treaty in place.

The OECD recognises, for example at Paragraph 47 of the 2008 Commentary on article 7 of the Model Tax Convention (MTC), that the use of different acceptable approaches to capital attribution in the domestic laws of the PE’s host state and home state can give rise to double taxation. Paragraph 48 of the Commentary goes on to set out the practical solution agreed between OECD member countries, in the context of the business profits article in the 2008 MTC. This is that the attribution of capital derived from the application of the approach used by the PE host country will be accepted for the purposes of double taxation relief provided that two conditions are met. These are:

  • that the difference in capital attribution between home and host country results from conflicting domestic law choices of method, and
  • that there is agreement that the host country has used an authorised approach and that, in the particular case, that approach gives a result consistent with the arm’s length principle.

This approach will apply both for the purpose of giving double taxation relief and for branch exemption, although it will not be applicable where for the purposes of branch exemption the terms of the OECD MTC are assumed in the absence of a full treaty.

Where there is a treaty in place between the UK and PE host state that is not a full treaty it may be possible, within the terms of that treaty, to resolve double taxation issues in relation to the application of different capital attribution approaches.

Allotted free capital outside the arm’s length range

TIOPA10/S43(6) makes it clear that the attribution of capital in accordance with S43(3) - (5) prevail over any allotment of capital to the PE by the company. If any amounts of free capital allotted to PEs in the company’s books and records are in excess of the amounts to be attributed under S43(3) - (5) they must be adjusted downwards for the purposes of the tax computation to give a result consistent with these provisions.