Reforms to the UK’s transfer pricing, permanent establishment and Diverted Profits Tax rules

Why should I read this?

As part of the government’s Spring 2025 Tax Update, HMRC launched a technical consultation on draft legislation for the reform of transfer pricing, permanent establishment and Diverted Profits Tax (DPT) (the Technical Consultation).

This follows HMRC’s January 2024 summary of responses to its June 2023 consultation on the same topic, which we discussed in a previous briefing and an article for Taxation magazine. The previous consultation was launched under the former Conservative government, but the new Labour government confirmed its commitment to continue progressing the reforms in its Corporate Tax Roadmap, published alongside the Budget in October 2024.

HMRC also launched, as part of the Spring 2025 Tax Update, a policy consultation on transfer pricing scope and documentation (the Transfer Pricing Policy Consultation). The government recommends that the two consultations are reviewed together, as a package of proposals on international tax reform.

The draft legislation which is the subject of the Technical Consultation implements various changes to the UK’s rules in relation to transfer pricing, permanent establishment and DPT, including:

• introducing a general exemption from UK:UK transfer pricing where both persons are subject to corporation tax (CT), taxable at the same rate;
• amending the statutory definition of a permanent establishment to align it with the 2017 OECD Model Tax Convention and amending the Investment Manager Exemption (IME) to ensure it remains fit for purpose in light of this change; and
• withdrawing DPT as a separate tax and creating a new charging provision for Unassessed Transfer Pricing Profits (UTPP) within CT, which will retain the essential features of the DPT regime.

The Transfer Pricing Policy Consultation seeks input on proposals to:

• amend the exemption from UK transfer pricing for small and medium-sized enterprises (SMEs); and
• introduce a requirement for multinationals to report information on cross-border related party transactions to HMRC through an International Controlled Transactions Schedule (ICTS).

What should I do?

Both consultations will run until 7 July 2025. All businesses which are, or may be, affected by the changes, together with their advisors and representatives, should carefully review the draft legislation and proposals and consider responding to the consultations.

What else do I need to know about the reforms to the UK’s transfer pricing, permanent establishment and Diverted Profits Tax rules?

Technical Consultation

Transfer pricing

The draft legislation implements changes to various aspects of the UK’s transfer pricing rules, which are intended simplify the application of the current legislation, update the rules in line with international standards, reduce compliance obligations on businesses and address areas of potential legislative weakness.

One notable change is to exempt domestic transactions between UK companies in scope of transfer pricing where there is no risk of tax loss. The draft legislation introduces a general exemption from UK:UK transfer pricing where both persons are subject to CT, provided each person is taxable to CT at the same rate. This is supplemented by a list of exclusions to prevent opportunities for tax arbitrage.

HMRC will have the ability to issue a transfer pricing notice to disapply the exemption, and taxpayers will be able to elect to apply transfer pricing should they wish to do so.

Other proposed amendments include changes to the participation condition and changes to valuation in relation to intangibles transactions between related parties. The draft legislation also explicitly confirms that the UK’s transfer pricing legislation should be interpreted in accordance with OECD principles.

Permanent establishment

The draft legislation brings the UK’s permanent establishment rules in line with the latest international consensus on the definition of a permanent establishment and the attribution of profits to a permanent establishment. The draft legislation includes clarifications regarding how OECD documents may be used to interpret the UK’s permanent establishment legislation.

Proposed changes include amending the statutory definition of a permanent establishment to align it with the 2017 OECD Model Tax Convention. In order to address concerns regarding the impact on the asset management industry of moving to the latest OECD definition of a dependent agent permanent establishment (DAPE), the consultation proposes amendments to the IME legislation, as well as updates to Statement of Practice 1/01, which provides guidance on how to interpret the IME.

Diverted Profits Tax

The draft legislation provides for the withdrawal of DPT as a separate tax, and the creation of a new charging provision for UTPP within CT, which will retain the essential features of the DPT regime.

This approach is intended to clarify the relationship between the taxation of diverted profits and transfer pricing and to enable businesses to benefit from the UK’s treaty network features such as access to the Mutual Agreement Procedure to remove double taxation.

This approach would also result in a closer alignment with the CT enquiry framework, which HMRC considers would result in significant simplification and improved certainty for businesses and HMRC.

Transfer Pricing Policy Consultation

The Transfer Pricing Policy Consultation seeks views on two related proposals, which are designed to protect the UK tax base against cross-border profit diversion by multinational enterprises (MNEs) and align the UK more closely with international peers.

SME exemption

Currently, the vast majority of transactions carried out by SMEs are exempt from UK transfer pricing. The government’s first proposal in the Transfer Pricing Policy Consultation is to amend this exemption.

The proposals include the potential removal of the exemption for medium-sized enterprises and possible changes to the definition of small enterprises. (Given the proposed amendments to UK:UK transfer pricing discussed above, in general transfer pricing is expected to apply only to cross-border transactions.)

Reporting requirement

The second proposal in the Transfer Pricing Policy Consultation is to introduce a requirement for multinationals to report information on cross-border related party transactions to HMRC through an ICTS. This information would assist HMRC by facilitating automated, data-led risk assessment and more accurate identification of transfer pricing risk. It is also expected to increase efficiency by promoting tax compliance and reducing the length of transfer pricing enquiries.

The Transfer Pricing Policy Consultation seeks views on the introduction of this requirement and its proposed scope and content.

The Transfer Pricing Records Regulations 2023 currently require the largest businesses to maintain specific transfer pricing documents (the master file and local file) in accordance with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, and to provide those documents on request. (We previously wrote a briefing on the government’s consultation on the draft version of these regulations.)

The government has confirmed that businesses in scope of the master file and local file requirements should largely be able to use their existing transfer pricing analysis when completing the ICTS. The government is also open to potentially allowing businesses to exclude data provided in the ICTS from the local file.

Comment

The government has consulted effectively with taxpayers in relation to the development of the proposed transfer pricing, permanent establishment and DPT reforms, many of which were set out in HMRC’s January 2024 summary of responses to its June 2023 consultation. It is particularly heartening that the government has dealt with stakeholder concerns regarding the operation of the IME in light of the UK’s definition of a permanent establishment being aligned with the 2017 OECD Model Tax Convention. The proposed changes to the IME should ensure the asset management industry continues to be protected, while simplifying the operation of the IME.

The Transfer Pricing Policy Consultation emphasises the government’s intention to take a fair and proportionate approach to the proposed changes and to mitigate any additional administrative burden on businesses wherever possible. However, the practical impact of these changes (if introduced) remains to be seen. Potentially affected multinationals should keep a close eye on developments in relation to the obligation to report information on cross-border related party transactions to HMRC through an ICTS, in order to ensure they are prepared to comply with the new requirement.

Next Steps

The responses to the Technical Consultation will feed into the drafting of the final legislation, which the government expects to include in Finance Bill 2025-26.

After reviewing the responses to the Transfer Pricing Policy Consultation, the government will publish its response. If the government decides to pursue the reforms, it will work towards implementation at a future fiscal event.

Further reading

Changes to the UK’s transfer pricing, permanent establishment and diverted profits tax rules proposed

Reform of UK law in relation to transfer pricing, permanent establishment and Diverted Profits Tax

HMRC consultation on draft transfer pricing records regulations