Foreign Branch Exemption: What the New HMRC Rules Mean for International Businesses

The changes will remove the current element of choice available to companies and, from 2027, make the foreign branch exemption regime mandatory in most cases. While the reforms are primarily aimed at preventing overseas losses being used to reduce UK tax liabilities, they could have wider implications for businesses with existing or planned international operations.

What is a foreign branch exemption?

A UK-resident company carrying on activities overseas may do so either through a separate subsidiary company or through a foreign permanent establishment (PE), commonly known as a branch. Under the current rules, profits generated by a foreign branch are generally within the scope of UK corporation tax. However, companies can elect into the Foreign Branch Exemption regime, under which both profits and losses of the foreign branch are excluded from UK corporation tax calculations.

The election is irrevocable and applies to all foreign branches operated by the company. Businesses have therefore traditionally needed to weigh up whether the benefit of exempting future profits outweighs the loss of relief for any future overseas losses.

What is changing?

HMRC has announced that the exemption will become mandatory rather than elective. For accounting periods beginning on or after 1 January 2027, profits and losses attributable to foreign branches will automatically be exempt from UK corporation tax.

In practical terms, this means:

• Foreign branch profits will generally fall outside the UK corporation tax regime.

• Foreign branch losses will no longer be available to offset against UK taxable profits.

• Businesses will no longer be able to choose whether or not to apply the exemption.

For many companies the change may appear relatively straightforward. However, for groups that have historically relied on overseas branch losses to reduce UK tax liabilities, the financial impact could be significant.

Earlier introduction for oil and gas businesses

The new rules will apply earlier to companies carrying on activities relating to oil and gas exploration and extraction through foreign branches.

For these businesses, the mandatory exemption will take effect from 1 September 2026. HMRC has confirmed that affected companies will be treated as having their accounting period end on 31 August 2026, with the new regime applying from the following day.

This accelerated timetable leaves relatively little time for affected businesses to assess the impact and consider any actions that may be required before the change takes effect.

Why is HMRC introducing the change?

According to HMRC, the current rules can create situations where losses generated overseas are used to reduce UK corporation tax liabilities, but the corresponding foreign profits never ultimately bear UK tax.

HMRC highlights two particular scenarios:

• Future foreign profits may be largely sheltered from UK tax by double tax relief.

• A profitable overseas branch may subsequently be transferred into a local subsidiary company, meaning future profits fall outside the UK tax net.

The government’s view is that this creates an imbalance, with relief being obtained in the UK for overseas losses without a matching UK tax charge arising when the overseas operations become profitable. The reforms are intended to protect the UK’s corporation tax base while maintaining a territorial approach to taxing overseas activities.

Transitional rules

The announcement also includes important transitional provisions.

HMRC intends to prevent losses and certain other amounts arising before the new regime takes effect from being carried forward and used against UK profits arising after the commencement date. In addition, existing “loss clawback” provisions associated with the current elective regime will be repealed.

An anti-avoidance provision is also being introduced to counter arrangements designed to accelerate the use of losses before the new rules begin or otherwise reduce the impact of the reform. HMRC has indicated that certain anti-avoidance measures may apply to arrangements entered into from 13 July 2026 onwards. While the policy intention is clear, businesses will need to review the final legislation carefully to understand precisely how the rules will work in practice and whether any existing planning or commercial arrangements could be affected.

What should businesses do now?

Although the main commencement date is not until 1 January 2027 for most companies, businesses with foreign branches should not leave their review until the last minute.

Companies should consider:

• Whether they currently rely on foreign branch losses to reduce UK taxable profits.

• The potential impact on future effective tax rates and cash flow.

• Whether existing overseas structures remain appropriate.

• The treatment of any accumulated branch losses and transitional amounts.

• The interaction with local overseas tax rules and reliefs.

For groups with significant international operations, particularly those in capital-intensive sectors where overseas losses can arise in the early years of a project, the changes could materially alter the economics of future expansion plans.

Final thoughts

The move to a mandatory foreign branch exemption represents one of the most significant changes to the taxation of overseas branches since the regime was introduced. While the government’s intention is to prevent overseas losses from reducing UK tax without a corresponding UK charge on future profits, the impact will extend far beyond a small number of multinational groups.

Businesses with overseas branches should use the time available before implementation to model the effect of the changes and ensure there are no unexpected consequences once the new regime comes into force.

If you would like to discuss how these changes may affect your business, please contact a member of our Corporate Tax team.