Why establishing a UK PE is only the jurisdictional threshold — and why profit attribution has become an even more important part of the analysis from 2026

In my previous article, I considered an international group whose transfer pricing and CFC review had exposed a wider problem.

The overseas principal legally owned the intellectual property, contractually assumed the principal commercial risks and retained the residual profit.

The UK company employed much of the management and operational workforce.

The documentation said that important decisions were made overseas.

The contemporaneous evidence showed that some of them were not.

That led the group through four separate questions.

Transfer pricing.

CFC.

Corporate residence.

Permanent establishment.

The residence analysis ultimately concluded that the overseas company remained non-UK resident, including after considering the relevant treaty.

But the permanent establishment analysis produced a different result.

Certain activities carried out in the United Kingdom were sufficient to create a UK taxable presence of the foreign enterprise.

That was important.

It was not, however, the end of the exercise.

It simply changed the question.

The finance director now asked:

If we have a UK permanent establishment, how much of the overseas company’s profit becomes taxable in the UK?

The answer was not:

Whatever profit relates to UK customers.

It was not:

The profit on the contracts negotiated in London.

And it was certainly not:

A percentage of the foreign company’s residual profit based on the number of UK employees.

Finding the PE established the United Kingdom’s jurisdictional threshold.

Profit attribution determined the amount potentially taxable here.

Those are two different exercises.

The existence of a PE does not determine its profit

This distinction is fundamental.

A permanent establishment tells us that the foreign enterprise has sufficient activity in the United Kingdom for the UK to exercise taxing rights, subject to the applicable treaty.

It does not tell us the quantum of the profit attributable to that activity.

Under the separate enterprise principle, the UK operations must broadly be hypothesised as if they were a separate and independent enterprise conducting the relevant activities under comparable conditions and dealing independently with the remainder of the foreign company.

Only the profit attributable to that hypothetical enterprise falls within the UK PE charge. HMRC’s current guidance expressly applies this arm’s-length, separate-enterprise approach. (GOV.UK)

That distinction immediately mattered in this case.

The overseas principal had £18 million of reported trading profit.

The existence of a UK PE did not transform £18 million into UK taxable profit.

The group had to identify what economic activity the PE itself should be treated as performing and what assets, risks and capital belonged to that hypothesised enterprise.

Only then could the profit calculation begin.

The 2026 changes make the attribution framework even more explicit

There was an additional reason why the analysis mattered.

For chargeable periods beginning on or after 1 January 2026, the UK legislative framework for PE profit attribution was updated.

HMRC explains that the legislation now refers directly to the OECD Model Tax Convention, its Commentary, the OECD Transfer Pricing Guidelines and the OECD’s work on the attribution of profits to permanent establishments. The Finance Act 2026 amendments expressly incorporate that framework into the interpretation of the UK separate-enterprise rules. (GOV.UK)

The practical message is important.

PE attribution cannot safely be approached as an accounting allocation exercise.

It is a functional and economic analysis.

The accounts are evidence.

They are not necessarily the answer.

Step one was to hypothesise the UK PE as an enterprise

The group therefore returned to the facts.

Not:

What income was booked to London?

But:

What would the UK operations look like if they were treated as a separate enterprise?

That required the group to identify the activities actually performed through the PE.

Who originated important customer relationships?

Who determined negotiating parameters?

Who possessed authority to make commercial concessions?

Who evaluated the relevant risks?

Who decided whether the foreign enterprise should accept those risks?

Who managed those risks after the contract had been entered into?

Who performed functions connected with the development or exploitation of the relevant intangible assets?

Which assets would the hypothesised UK enterprise require in order to perform those functions?

And what capital would an independent enterprise carrying on those activities reasonably need?

This was closely related to the functional analysis already undertaken for transfer pricing and CFC purposes.

But once again, the legal question was different.

The same employee could appear in several analyses.

That did not mean the same profit could simply be attributed several times.

The UK employees did not perform every function for the same enterprise

This became one of the most important factual distinctions.

Several UK executives were employed by the UK subsidiary.

But employment contracts did not answer every attribution question.

The group had to determine the capacity in which those individuals were acting when they performed particular activities.

Some functions were clearly performed for the UK subsidiary.

Operational support.

Local management.

Administrative activity.

Technical services.

Those functions had already been considered when determining the arm’s-length remuneration of the UK company.

Other activities were different.

Certain executives had participated directly in the foreign principal’s customer negotiations.

They had determined commercial parameters for contracts entered into by the foreign company.

They had made decisions concerning risks legally assumed by the overseas enterprise.

They had participated in activities economically connected with assets held by the foreign company.

Those activities had to be analysed separately.

The existence of a UK subsidiary did not make them disappear.

Equally, the existence of a PE did not justify attributing to the PE functions for which the UK subsidiary had already been appropriately remunerated.

The group therefore needed to answer a more difficult question:

Which economic contribution belonged to the UK company, and which belonged to the hypothesised UK PE of the foreign company?

Without that distinction, double counting was almost inevitable.

Transfer pricing remuneration was not automatically PE remuneration

Suppose the original UK company earned £3 million under its historical cost-plus arrangement.

The transfer pricing review concluded that this was insufficient.

After accurately delineating the controlled transactions, the UK company’s appropriate arm’s-length profit was increased by £4 million.

The group could not then assume that the PE should receive another £4 million merely because some of the same personnel appeared in the PE analysis.

That would confuse two different relationships.

Transfer pricing examines transactions between legally separate enterprises.

PE attribution hypothesises dealings between different parts of the same legal enterprise.

The analytical tools overlap substantially.

The taxable persons and the attribution exercise do not.

The group therefore created a functional map showing, for each material activity:

• the individual performing it;
• the capacity in which that person was acting;
• the entity or PE to which the function related;
• the asset or risk affected;
• the profit stream generated by that asset or risk; and
• whether that economic contribution had already been remunerated elsewhere in the model.

That final column became particularly important.

A profit bridge needs an anti-double-counting mechanism.

Revenue was not attributed merely because the customer was in the UK

The commercial team initially proposed a simple approach.

Identify contracts with UK customers.

Allocate the associated profit to the UK PE.

That was rejected.

Customer location does not, by itself, determine PE profit attribution.

A UK customer may purchase a product developed, manufactured, financed, strategically managed and commercially exploited almost entirely outside the United Kingdom.

Conversely, a contract legally concluded with a foreign customer may generate profit substantially connected with functions carried out through a UK PE.

The attribution exercise follows the economic functions, assets and risks of the hypothesised enterprise.

It does not merely follow the invoice address.

HMRC similarly approaches UK PE profits through a detailed understanding of the UK activities and their relationship with the wider enterprise, using transfer-pricing methodology to determine the arm’s-length result. (GOV.UK)

The intangible return became the difficult part

The most material profit stream related to intellectual property.

Legal ownership sat overseas.

That remained relevant.

But it did not determine the entire attribution analysis.

The group examined how the relevant intangible had been developed and exploited.

UK personnel had contributed to project selection.

They had participated in development decisions.

They had assessed whether projects should continue.

They had controlled important commercial responses when development risk materialised.

The foreign company, however, also performed genuine activities.

Its directors controlled certain licensing decisions.

Foreign personnel managed particular markets.

Capital was deployed overseas.

Certain strategic decisions were genuinely made outside the United Kingdom.

The result was therefore not binary.

It was not:

IP legally owned overseas, therefore no UK PE return.

Nor was it:

UK personnel contributed to the IP, therefore all intangible profit belongs to the UK.

The attribution needed to reflect the specific functions and risks connected with the particular income stream.

This was precisely why the group’s original “single residual profit to the principal” model had become difficult to defend.

The residual profit was economically heterogeneous.

Different parts of it arose from different assets, risks and activities.

Capital could not be ignored

There was then another issue that receives less attention in many PE reviews.

Capital.

A hypothesised separate enterprise cannot simply be given all of the debt and none of the equity that produces the most favourable tax result.

The attribution exercise must consider the equity and loan capital that the PE would reasonably require having regard to the assets, risks and activities attributed to it.

That can affect the amount of financing expense deductible in determining the PE’s taxable profit.

HMRC’s guidance therefore treats capital attribution as part of the separate-enterprise analysis and expressly notes that the assets attributed to the PE may differ from those recorded in a branch balance sheet. (GOV.UK)

This mattered because the overseas company had significant external and intra-group financing.

Once certain assets and risks were attributed to the UK PE, the group could not simply allocate the related gross return to the United Kingdom while leaving the capital structure entirely offshore.

Assets, risks, funding and profit had to reconcile.

The PE accounts were the starting point, not the conclusion

The foreign company had historically prepared management information for its UK activities.

That was useful.

But those accounts had been prepared for operational purposes, not under an AOA profit-attribution analysis.

Some expenditure attributed to the UK related to activities of the UK subsidiary.

Other costs recorded overseas supported functions attributable to the UK PE.

Certain assets used economically by the UK operations were not reflected in the UK balance sheet at all.

HMRC describes accounts for the UK activities as the usual starting point for calculating chargeable profits.

That wording is important.

Starting point.

Not statutory answer. (GOV.UK)

The accounting perimeter therefore had to be reconstructed around the functional perimeter.

The group rebuilt the £18 million profit bridge

At this stage, the earlier £18 million figure could finally be reconsidered.

The group did not ask:

What percentage should we allocate to the UK?

It reconstructed the economic profit sequentially.

First, it determined the arm’s-length remuneration of the UK subsidiary under transfer pricing principles.

Second, it identified the activities properly attributable to the UK PE of the foreign enterprise.

Third, it attributed the relevant assets and risks to that hypothesised PE.

Fourth, it determined the dealings between the PE and the remainder of the foreign enterprise that would be recognised under the separate-enterprise analysis.

Fifth, it applied appropriate transfer-pricing methodologies to those dealings.

Sixth, it considered the appropriate capital and financing position.

Only after that did it quantify the UK PE profit.

The remaining foreign profit then had to reconcile with the group’s CFC analysis.

The CFC rules use related concepts because Chapter 4 itself draws on the OECD’s PE attribution framework, including a functional analysis of assets, risks and significant people functions. But the statutory CFC gateway remains a separate calculation and must be applied as such. (GOV.UK)

The objective was not to make every tax provision produce the largest possible UK number.

It was to ensure that each part of the economic profit was taxed under the correct mechanism and that the same contribution was not counted more than once.

A PE can exist and still have a relatively limited profit

This is another point worth emphasising.

Finding a PE does not necessarily produce a substantial UK tax liability.

The facts may demonstrate that the UK activity crosses the PE threshold while the economically significant assets, risks and functions remain predominantly outside the United Kingdom.

In that situation, the attributed profit may be relatively limited.

The opposite can also occur.

A group may regard the PE as a technical filing issue because only a small number of employees operate in the United Kingdom.

But if those individuals perform economically significant functions connected with valuable assets or material commercial risks, the attributed profit may be considerably greater than their headcount suggests.

People numbers are therefore a poor proxy.

So are costs.

So is revenue.

The analysis needs to follow value creation at the level relevant to the enterprise.

The evidence file changed again

The group had originally thought that its defence would consist principally of:

intercompany agreements;

board minutes;

transfer pricing reports; and

foreign substance documentation.

By the end of the review, the evidence file looked very different.

It included customer negotiation histories.

Delegations of authority.

Pricing approval records.

CRM information.

Investment papers.

Product-development decisions.

Employee calendars.

Emails showing when commercial commitments had actually been made.

Records of who managed risks after contracts were signed.

Evidence of who controlled relevant assets.

Internal financial information linking those functions to individual profit streams.

And documentation showing how the UK subsidiary remuneration, PE attribution and CFC computation reconciled.

That was much closer to the economic question HMRC could actually ask.

The next question for international groups

Where a foreign principal has significant UK activity, groups should not stop after asking whether a permanent establishment exists.

The next questions are more important:

What functions are actually performed through that PE?

Which assets and risks would be attributed to it?

In what capacity are UK personnel performing those functions?

Has a UK group company already received an arm’s-length return for the same economic contribution?

What internal dealings would be recognised between the PE and the remainder of the foreign enterprise?

What capital would the hypothesised PE require?

What profit would a genuinely separate enterprise performing those functions, using those assets and controlling those risks earn?

And does that answer reconcile with the transfer pricing and CFC positions already taken elsewhere in the group?

A permanent establishment is a taxable presence.

It is not a formula for allocating profit.

The more difficult question begins after the PE has been found.

It is not:

How much foreign profit can the UK tax?

It is:

What profit did the UK permanent establishment economically earn?

That distinction is where a technically defensible PE analysis begins.

How Vectigalis AC Tax can assist

Vectigalis AC Tax advises UK and international groups on complex cross-border structures involving transfer pricing, permanent establishments, CFCs, corporate residence and profit attribution.

Our work includes PE risk reviews, functional and factual analyses, dependent-agent and fixed-place PE assessments, AOA profit-attribution modelling, significant people function and control-over-risk reviews, attribution of assets and capital, reconciliation of subsidiary and PE remuneration, CFC gateway analysis, historical exposure quantification and redesign of governance and operating models.

For groups with overseas principals, IP companies, regional headquarters, procurement hubs or other foreign entities supported by UK personnel, identifying the PE is only one part of the exercise.

The more important question is whether the resulting allocation of profit follows the functions, assets, risks and decision-making evidenced by the way the business actually operates.

MAIL: angelo@vectigalistax.co.uk

Angelo Chirulli ADIT FCA BFP IFA TEP CPA
Vectigalis AC Tax