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The rules described in this article will not apply if different rules are included in the relevant double taxation agreement; in such a case the rules in the agreement take precedence.

Profits are attributed to the UK permanent establishment (PE) on the basis that the establishment is a distinct entity, dealing independently with the non-resident company¹.

The legislation describes these provisions as 'the separate enterprise principle'².

For this purpose, it is assumed that the PE has the same credit rating as the non-resident company and that it has such equity and loan capital as would be reasonably expected in such a distinct entity³. Regulations applying this rule to insurance companies provide a different basis for attributing capital to a UK PE⁴.

This rule is designed to prevent thin capitalisation, as the interest and other funding costs of the PE are calculated so that the PE only obtains a tax deduction for an arm's length amount of those costs. In relation to banks, HMRC have issued guidance as to