Under the Finance Bill 2011, the election to apply the exemption (under section 18A of CTA 2009) becomes irrevocable at the start of the first accounting period to which it applies (section 18F, CTA 2009).

However, the draft legislation allowed a company to revoke an election before the filing date for the company tax return for the first accounting period for which the election had effect (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses: Irrevocable elective regime with "cooling-off" period). This change shortens the revocation period.

If a company opts into the regime under section 18A of CTA 2009, appropriate adjustments must be made to secure that any profits or losses taken into account in determining the exempt branch profits (foreign permanent establishments amount (FPEA)) are left out of account in computing the company’s chargeable profits. These are known as "exemption adjustments" (section 18A(2), CTA 2009).

Broadly, the FPEA consists of total branch profits in a territory (relevant profits amount) less the total branch losses in that territory (relevant losses amount) (sections 18A(4)-(7), CTA 2009).

This change seems to provide the mechanism for exempting branch profits and does not appear to be a substantive change. However, it differs from the draft legislation, which simply referred to the FPEA being left out of account in computing the profits and losses of the company for corporation tax purposes (see section 18A(1) of CTA 2009 under the draft legislation).

Unlike the draft legislation, the Finance Bill 2011 does not exclude from exemption companies whose business is wholly or mainly investment business. The exclusion was in section 18C(3) of CTA 2009 under the draft legislation. Although there is no explanation of this change, it had been suggested that excluding branches of such companies could be viewed as state aid for other companies. This distinguishes the branch exemption from the CFC rules under which investment business is generally not an exempt activity (see Practice note, Controlled foreign companies and attribution of gains: tax: The CFC regime: attributing income to the UK).

However, the exclusions remain for close company chargeable gains and small company branches in territories whose treaties do not have non-discrimination clauses (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses: Close company chargeable gains excluded and Exemption for small company branches in full treaty territories and section 18P of CTA 2009).

The FPEA is still defined by reference to individual treaties if they contain a non-discrimination clause (full treaties) or, in any other case, as if such treaties were full treaties in the terms of the OECD Model Tax Convention (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses: Exempt profits defined by reference to treaties with a non-discrimination clause).

However, the Finance Bill 2011 now provides that, where a full treaty allows a foreign territory to tax profits of a non-resident without any requirement that such profits be attributable to a permanent establishment in that territory, a relevant profits amount will include the profits on which such tax would be paid to the extent that the profits were attributable to that permanent establishment. Relevant losses amounts are calculated in the same way. (Sections 18A(8) and (9), CTA 2009.)

Also, if a treaty does not provide for the foreign tax credit to be calculated by reference to the same profits that the foreign territory treated as taxable, relevant profits amounts and relevant losses amounts must be calculated as if there were such provision (section 18A(10), CTA 2009).

Branch chargeable gains are exempted, again by exemption adjustments (section 18B(1), CTA 2009). However, the Finance Bill 2011 adds that gains on immoveable property are also exempt to the extent that such property has been used for the purposes of the branch business (section 18B(2), CTA 2009).

The Finance Bill 2011 also contains a provision to limit the application of the exemption to foreign gains or losses realised before the exemption takes effect. An earlier gain or loss can be taken into account in the computing a relevant profits amount or relevant losses amount only to the extent that the foreign tax was paid in respect of an accounting period that the company has elected to exempt (section 18B(3), CTA 2009).

The regime contains rules (borrowed from the CFC regime) to prevent the artificial diversion of profits to exempt branches (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses: CFC-style anti-diversion rule). These include the "lower level of tax" test, and the motive and de minimis profit carve-outs (as to which, see Practice note, Controlled foreign companies and attribution of gains: tax: The CFC regime: attributing income to the UK).

The Finance Bill 2011 amends both the "lower level of taxation" test (see "Lower level of tax" test) and the de minimis profit exemption (see De minimis profit exemption). It also provides for the relevant profits amount to be reduced proportionately if the motive test is only partly failed (see Proportionate reduction of relevant profits amount). There are also specific transitional rules for the motive test (see Motive test transitional rules).

The Finance Bill 2011 modifies the draft transitional rules by allowing the company to specify in its tax return for the period in which the losses are exhausted which part of the branch profits are exempt (section 18K(4) of CTA 2009) and eliminating credit for foreign tax on branch profits during the transitional period.

Broadly, when a company opts into the regime, it must match its branch losses in the six years immediately before the elected exempt periods with profits in the first loss-making period or subsequent periods (and, therefore, extinguish the losses) (section 18J, CTA 2009). If, at the end of this exercise, losses exceed profits (the difference being the opening negative amount), the matching rules apply.

In the first period to which the exemption election applies, profits are used to reduce the total opening negative amount (instead of being exempt). The opening negative amount cannot be reduced to nil. If a loss remains after such matching, further matching is made in the following period(s) (as the case may be). Exemption only begins when, and to the extent that, profit in a period exceeds the remaining opening negative amount. (Sections 18K(1)-(3), CTA 2009.) Under the Finance Bill 2011, the company can then specify which part of the unused branch profits the exemption applies to in the final period in which profits are used to reduce losses in this way (section 18K(4), CTA 2009).

If branch losses exceed £50 million in an accounting period beginning up to six years before the Finance Bill 2011 is passed, that period, and every later period that would not otherwise be subject to the matching requirement, are subject to that requirement (paragraph 33, Schedule 13, Finance Bill 2011). This delays the application of the exemption for "large" losses.

The Finance Bill 2011 does not contain the draft legislation's new sections 43(9) and (10) of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010) that provided for credit for foreign tax on branch profits during the transitional period (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses: Credit relief during the transitional period).

The transitional rule is subject to the new streaming provisions (see Transitional rule: territorial streaming) and the new rule for transfers of foreign permanent establishment business (see Transitional rule: permanent establishment business transfers).

The Finance Bill 2011 allows a company to apply the transitional rule (see Transitional rule: exhausting pre-exemption losses) separately to (or "stream") losses in a particular territory so that they do not delay the application of exemption to other territories in relation to which the company would otherwise have no (or a shorter) transitional period.

If the effect of a company's transfer of branch business to a connected company that is (or later becomes) UK resident is to tax the profits of the companies (taken together) less under sections 18K to 18N of CTA 2009 than the transferee would be taxed if the branch business were at all material times carried on by the transferee, those sections apply to the transferee (and the transferor, if appropriate) with any adjustments necessary to cancel that advantage (section 18O, CTA 2009).

The government considered whether legislation was needed for capital allowances (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses technical note: Special capital allowances rules). The following provisions are intended to ensure that capital allowances are taken into account in the FPEA calculation to an appropriate extent.

Notional plant and machinery allowances (and charges) that would be available to a company absent the branch exemption are to be taken into account automatically in calculating branch profits or losses for all accounting periods after election under section 18A of CTA 2009 (section 18C(1), CTA 2009). As suggested by the government, for the purpose of establishing these notional allowances (or charges), the Capital Allowances Act 2001 (CAA 2001) is assumed to apply as if the separate branch activity (under new section 15(2A)(a) of CAA 2001) was a qualifying activity for capital allowances purposes, provided that it would be but for the effect of the election under section 18A of CTA 2009.

For the purposes of calculating the notional allowances (and charges), the qualifying expenditure attributable to the permanent establishment on the same plant and machinery starting to be used for the separate activity under new section 15(2A)(a) of CAA 2001 is its tax-written down value (section 18C(2), CTA 2009 and new section 62A, CAA 2001). (See also Significant changes to other Acts: CAA 2001: disposal event and disposal value.)

Profits or losses from plant or machinery leases (within section 70K of CAA 2001) are to be disregarded when calculating any relevant profits amount or relevant losses amount if any allowance (other than a section 18C(1) notional allowance) has been made to the company (or a connected company) as lessor (also defined by section 70K of CAA 2001) for expenditure on the provision of the leased plant or machinery (sections 18C(3) and (4), CTA 2009).

(See also Significant changes to other Acts: CAA 2001: disposal event and disposal value.)

The Finance Bill 2011 contains a provision that all claims and elections (other than those for capital allowances: see Capital allowances) that would reduce any relevant profits amount, or increase the relevant losses amount, are assumed to have been made in calculating branch profits to be exempted (section 18C(5), CTA 2009).

During the consultation, the government stated that companies would be expected to minimise the profits taxed in the branch jurisdiction but there was no explicit rule in the draft legislation requiring companies to do this (see Legal updates, Foreign branch exemption: draft Finance Bill 2011 clauses: Duty to minimise branch taxation and Foreign branch exemption: draft Finance Bill 2011 clauses technical note: Duty to minimise branch profits).

The Finance Bill 2011 contains a new rule designed to prevent the use of branches to avoid withholding obligations under Part 15 of the Income Tax Act 2007 (ITA 2007). Profits or losses are to be excluded from any relevant profits amount or relevant losses amount (and will not, therefore, benefit from exemption) if both of the following apply:

(Sections 18D(1) and (2), CTA 2009.)

This anti-avoidance rule does not apply to banks unless the transaction is part of arrangements the main purpose (or one of the main purposes) of which is to avoid a Part 15 withholding obligation (sections 18D(3) and (4), CTA 2009).

Any corporation tax relief under Chapters 2 or 3 of Part 12 of CTA 2009 (as to which, see PLC Share Schemes & Incentives, Practice note, Employee share schemes: an introduction: Tax treatment for the company) is taken into account in determining the relevant profits or losses amounts of the exempt foreign permanent establishment in a particular territory to the extent that the relief is linked to the business carried on by the permanent establishment in that territory.

The extent to which any relief is so linked must be determined on a just and reasonable basis having regard to the extent to which the work of the employees concerned contributes to the purposes of the branch business. (Section 18E, CTA 2009.)

Section 18Q(1) of CTA 2009 provides that profits and losses arising from basic life assurance and general annuity business (within section 431(2) of the Income and Corporation Taxes Act 1988 (ICTA 1988)) are excluded from exemption. The remaining subsections of section 18Q are more specific to insurance businesses. Section 18C(2) of CTA 2009 under the draft legislation merely contained an exclusion from the exemption for long term business as defined in section 431(2) of ICTA 1988.

When a gain or loss is taken into account in calculating a relevant profits or losses amount for the purposes of section 18A of CTA 2009 and the disposal is a "no gain/no loss" disposal, the disposal value is that which, taking into account the effect of section 18A, secures neither a gain nor a loss for the transferor (new section 276A, Taxation of Chargeable Gains 1992, inserted by paragraph 12, Schedule 13, Finance Bill 2011).

(For more information on group chargeable gains, see Practice note, Tax on chargeable gains: general principles: Group relief.)

If a company carries on a business though permanent establishments outside the UK and makes an election under section 18A of CTA 2009 then, from the beginning of the first accounting period after the election is made, the business carried on in the permanent establishment is treated for capital allowances purposes as a separate activity the profits and gains of which are not chargeable to tax (new section 15(2A), CAA 2001, inserted by paragraph 14, Schedule 13, Finance Bill 2011). In other words, the separate permanent establishment activity is not a qualifying activity of the company for capital allowances purposes. The government suggested this "separate activity" treatment in the technical note on the draft legislation (see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses technical note: Special capital allowances rules).

When section 15(2A) of CAA 2001 applies, this is also a disposal event and a disposal value must be brought into account. The disposal value in this case is the tax written down value (new section 62A, CAA 2001, inserted by paragraph 16, Schedule 13, Finance Bill 2011). Section 62A does not apply (and the disposal value is market value) if both of the following apply:

"Relevant preceding accounting period" means the accounting period in which the election under section 18A of CTA 2009 is made or an earlier accounting period ending less than six years before the end of that accounting period.

Where qualifying expenditure on plant and machinery does not exceed £50 million, the relevant preceding accounting period will not include an accounting period ending more than 12 months before the day on which the Finance Bill 2011 is passed. Where the qualifying expenditure exceeds £50 million, any accounting period beginning up to six years before the day on which the Finance Bill 2011 is passed that would not otherwise be a "relevant preceding accounting period" is treated as such a period. (Paragraph 34, Schedule 13, Finance Bill 2011.)

The following payments are treated in the same way as payments paid or received by a non-UK resident for the purposes of withholding and accounting for UK income tax if they are paid or received by an exempt permanent establishment:

(For more information on the tax treatment of manufactured payments, see Practice notes, Stock lending: tax and Repos: tax.)

The exception from withholding for interest payable on an advance by a bank (see Practice note, Withholding tax: Interest payable on an advance from a UK bank) is extended to situations where the recipient is a bank that would be within the charge to corporation tax in respect of the interest but for an election under section 18A of CTA 2009 (section 879(1), ITA 2007 as amended by paragraph 18, Schedule 13, Finance Bill 2011).

Corporation tax deductions can be given for the cost of providing an employee share scheme, despite the operation of section 18A (sections 1007(2)(b) and 1015(2)(b), CTA 2009 as amended by paragraphs 8 and 9, Schedule 13, Finance Bill 2011).

Section 775 of CTA 2009 makes intra-group transfers of intangible fixed assets (IFAs) tax neutral. This will not apply if section 18A of CTA 2009 applies to the transferor and the IFA has at any time been held for the purposes of a permanent establishment of the transferor (new section 775(4)(c), CTA 2009, inserted by paragraph 5, Schedule 13, Finance Bill 2011).

If section 775(4)(c) of CTA 2009 applies but the IFA has not been held wholly for the purposes of a permanent establishment at all times in which an election under section 18A of CTA 2009 applied to the transferor, the transferee is treated as having acquired the IFA for such amount as is appropriate having regard to the operation of section 18A of CTA 2009 (new section 776A, CTA 2009, inserted by paragraph 6, Schedule 13, Finance Bill 2011).

(For the background to, and more information on, the IFA rules, see Practice note, Intangible property: tax.)

Amounts excluded under the branch exemption are not taken into account for the purposes of the debt cap (as to which, see Practice note, Limits on tax deductions for interest: the debt cap) (new sections 263(4A) and 317A, inserted by paragraphs 28 and 29, Schedule 13, Finance Bill 2011).

The existing section 43 of TIOPA 2010 will be rewritten. It will provide a stand-alone method of determining how much of a UK resident company's profits on which corporation tax is (or would be) chargeable is attributable to a permanent establishment for the purposes of section 42(2) of TIOPA 2010 (double taxation relief: limit on credit against corporation tax).

The Finance Bill 2011 provisions (paragraph 26 of Schedule 13) do not differ substantially from the draft legislation (as to which, see Legal update, Foreign branch exemption: draft Finance Bill 2011 clauses: Attributing capital to branches).

Finance Bill 2011 as introduced (clause 48 and Schedule 13) and explanatory notes (pages 173-196).