On 28 April 2025, HM Revenue and Customs (HMRC) proposed significant reforms to the UK’s transfer pricing and permanent establishment (PE) rules, and a repeal of the diverted profits tax, bringing that regime within UK corporation tax.
These changes build on a consultation initiated in 2023 as part of a stated effort to modernise UK rules and bring them further into line with both OECD standards and the approach adopted by peer jurisdictions. HMRC has now published draft legislation for further consultation and has invited comments by 7 July 2025. The government intends to introduce legislation in the Finance Bill 2025-26 with earliest implementation in January 2026.
1. Permanent Establishment
In an important change with impacts that may increase over time as double taxation treaties are updated, the proposals align the UK rules on PEs with “the latest international consensus” on the definition of PEs, drawing on the concept of a dependent agent PE in the 2017 OECD Model Tax Convention (2017 MTC).
Under the new legislation, a UK PE arises where “a person acting on behalf of the company habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts, that are routinely concluded without material modification by the company” (emphasis added).
Previously, the domestic test was whether “an agent has and habitually exercises their authority to do business on behalf of the company”. The new language does not precisely match the wording in the 2017 MTC, preserving the possibility, under UK common law, of a dependent agent arising in a case where either the agency or the principal is undisclosed.
Importantly, however, the UK domestic definition will continue to be overridden by relevant existing tax treaties with narrower definitions of a PE. As a result, this change is unlikely to have a widespread impact, but it could increase in importance over time if the UK includes the broader definition as part of any future treaty negotiations.
The UK’s rules on the attribution of profits to a PE would also be revised, purportedly to bring them further into line with the OECD Report on the Attribution of Profits to Permanent Establishments 2010.
The government has also proposed key changes to the scope of the investment management exemption. See our 6 May 2025 client alert “UK Government Targets Reform of the Investment Manager Exemption”. Reacting to concerns raised, the government has invited feedback on whether the wider alignment of the dependent agent definition with the 2017 MTC leads to a substantial change of the taxation of UK dependent agency PEs in the context of UK investment managers, notwithstanding the changes to the scope of the exemption.
Many peer jurisdictions have not adopted these definitions (suggesting there is not a consensus) and HMRC’s contention that the change to the UK domestic definition would not cover additional persons begs the question as to why this amendment is required.
2. Transfer Pricing
HMRC has proposed changes to the UK transfer pricing regime in several key areas:
A. The Participation Condition
The government has proposed to expand the scope of the UK transfer pricing rules by adopting:
- A new form of “direct participation” where two persons are subject to an agreement for common management, capturing situations where separately owned companies have different shareholders, but those shareholders have agreed to deal with their affairs as if they were effectively one business.
- An anti-avoidance provision ensuring participation when a person enters into arrangements with a main purpose of not meeting the participation condition — accepting that, where a company is sold for genuine commercial purposes, this test will not be met.
- A new power allowing HMRC to issue a transfer pricing notice requiring a taxpayer with a return that is under enquiry to file on the basis that the participation condition is met with respect to a particular provision or class of provisions, where there is considered to be common participation in the management, control or capital of companies on OECD standards but the UK participation condition has not otherwise been met.
- In an effort to tighten-up and clarify the current “acting together” rules, new legislation to aggregate the equity holding of lenders to determine whether they participate in the management, control or capital of the borrower. This rule will include arrangements where existing equity holders make loans, lenders who obtain an equity stake as part of the financing arrangement and lenders who subsequently obtain an equity stake as part of an arrangement involving an existing loan.
B. UK-UK Transactions
These proposed changes would exempt domestic transactions between UK companies from the UK transfer pricing rules where there is no risk to the UK tax base. Taxpayers will be able to elect to apply transfer pricing rules as normal should they wish to do so. The exemption is limited to transactions where both parties are subject to corporation tax at the same rate (the small profits rate should be noted in this context), and also does not apply to transactions (for example) across the oil and gas ring fence, or where the transaction at issue results in one party recognising income within the patent box regime. HMRC will also have the ability to issue a transfer pricing notice to disapply the exemption.
C. Intangible Fixed Assets
The interaction between the transfer pricing rules and the rules regarding transactions in intangible fixed assets between related parties is complex and has given rise to plenty of controversy in recent years. In particular, the requirement for taxpayers to consider both the market value and arm’s length price of an intangible asset in certain circumstances has been seen by some to create unfairness and allow HMRC to pick and choose between the standards when beneficial to the UK Treasury.
The proposed legislation intends to simplify the rules by applying only one valuation standard: The arm’s length price will be used for cross-border transactions within the scope of the UK’s transfer pricing rules; this will allow such transactions to be fully covered by advance pricing agreements. The existing market value rules will be retained in all other scenarios involving transactions between related parties.
Adjustments may continue to be made to either increase or decrease the consideration for intangible fixed assets that are acquired by way of a transfer, retaining an exception to the general “one-way street” principle which allows transfer pricing adjustments to be made only where there is a potential UK tax advantage. The one-way street continues to apply to licensed intangibles.
These changes are generally welcome given that the removal of the dual valuation standards is likely to reduce complexity and the potential for dispute. The retention of the two-way street for transfers may also provide businesses with additional comfort in relation to the onshoring of intangibles to the UK. One further step that would be beneficial would be for HMRC to clarify further the interaction between the provisions applicable to “transfers” and those applicable to “grants”, noting that transactions such as English law novations can be argued to fall within either or both elements of the regime.
D. Financial Transactions
The draft legislation is designed to align the UK’s domestic rules with the guidance in Chapter X of the OECD Transfer Pricing Guidelines.
Currently, the UK rules prohibit consideration of any guarantee when applying the UK’s transfer pricing rules to a provision relating to a security issued on a related party loan. However, as there is no clear definition of “guarantee” for these purposes, there has been uncertainty and some controversy regarding whether implicit support from a wider group could be taken into account in related party transaction pricing. To address this point, the draft legislation defines “implicit support”, stating that such support is not a provision capable of being adjusted under the UK rules. Therefore, implicit support will be taken into account for UK purposes.
Guarantees or other explicit support, as formally distinguished from “implicit support”, would now be taken into account for purposes of the UK rules, but an assessment will be required of whether or not such guarantees should be remunerated at arm’s length. Further, guarantees between parties that meet the participation condition will still be explicitly excluded from being at arm’s length where an amount would not have been lent by independent parties save for such guarantee. Consequential changes have been made to the compensating adjustment rules in light of the changes regarding guarantees.
HMRC’s proposals regarding “implicit support” are welcome insofar as certainty is concerned. However, groups will need to review their pricing of debt in light of these changes. Further, the amendments are proposed to take effect with respect to new debts or debts that are substantially amended after the date of the legislation becoming law, creating the possibility for controversy regarding amendments to related party debt that a taxpayer alleges has been only “insubstantially” amended.
E. International Controlled Transactions Schedule
HMRC is also proposing the introduction of a requirement for in-scope businesses to report information regarding certain cross-border related party transactions covering dealings between a UK-resident company and its overseas PEs, as well as dealings of UK PEs of foreign-resident companies.
This filing is referred to as the “ICTS”, with HMRC explaining their view that most major economies have a comparable requirement. The intention of the ICTS is to collect objective data in a structured, standardized way prior to HMRC opening enquiries and obtaining relevant transfer pricing reports. HMRC argue the new information will enable improvements in the efficiency and accuracy of HMRC’s identification of transfer pricing and PE risk.
HMRC proposes businesses be exempt from filing the ICTS where the total aggregated value of relevant cross-border related party transactions is below £1 million, and invite views as to whether multiple or alternative thresholds are preferred.
HMRC view the ICTS requirements as light touch compared to other jurisdictions (citing, for example, Australia’s regime) but that view is not obviously supported by a comparison and review of such regimes.
F. Additional Proposed Changes
Other changes include:
- Simplifying the rules on exchange gains and losses on loan relationships and derivative contracts by directly applying Part 4 T(IOP)A 2010, with carve-outs for gains and losses relating to instruments within certain hedging arrangements. The one-way street will also be relaxed so as not to disallow debits that represent a reversal of a foreign exchange or fair value credits.
- A limited documentation requirement as part of the ICTS template detailed above to accompany the changes relating to exchange gains and losses. HMRC have published a template to illustrate the type of information expected to be requested. • The requirement for HMRC’s commissioners to sanction transfer pricing determinations will be repealed.
- A technical amendment will confirm that the arm’s length principle in the UK’s transfer pricing rules must be interpreted in line with the OECD Model Tax Convention and Transfer Pricing Guidelines, regardless of whether there is a treaty in place.
- Medium-sized enterprises will be brought within the scope of the UK transfer pricing rules. The exemption for small enterprises will be retained, albeit with amended thresholds applying.
3. Diverted Profits Tax
The diverted profits tax (“DPT”) introduced in 2015 will be repealed and brought into UK corporation tax, with the creation of a new charging mechanism for “unassessed transfer pricing profits” at the rate of 31%.
HMRC may assess a UK company or UK PE of a non-UK resident company’s unassessed transfer pricing profits, effectively arm’s length profits which are not reflected in its UK corporation tax return for an accounting period, where: (a) the provision to which those profits relate results in an effective tax mismatch outcome; and (b) it is reasonable to assume that the structure of the provision or the arrangements in question is designed to have the effect of reducing, eliminating or delaying the liability of any person to pay UK or foreign tax. As with the DPT, this new charge to UK corporation tax will operate on a “pay to play” basis, whereby a company that is assessed to tax will be required to pay the tax in full before it is able to negotiate a refund or launch an appeal, operating under timelines that broadly reflect the statutory time limits and constraints that apply today under DPT.
Whilst the new corporation tax charge broadly reflects the underlying design of the DPT, there are several important differences. For example, the DPT charge on “avoided PEs” of non-UK resident companies will cease to apply, as will the obligation upon companies to notify HMRC within three months of the end of an accounting period if they are potentially liable to DPT. The new charge will also draw directly on the UK’s transfer pricing rules to quantify a charge to tax – with the “relevant alternative provision” of DPT being consigned to history.
Although the alignment with the corporation tax regime is welcome, given the beneficial double taxation convention implications, the replacement of the insufficient economic substance condition with the “design” condition outlined above may result in a wider spectrum of arrangements being subject to the regime and resulting possibility of higher rates. Taxpayers should carefully review cross-border arrangements where the relative non-tax benefits of such arrangements were identified as the reason for no charge to DPT arising.
4. Conclusions and Takeaways
HMRC’s proposed changes could be described as unsurprising in light of the 2023 consultation document and summarised responses. However, there are elements of the proposals that should be considered carefully by taxpayers as indicia of areas where future controversy may arise.
For example, the proposed changes to the scope of a PE under UK domestic law may reveal a perceived need for HMRC to agree to this expanded scope in future treaty negotiations, but may also reveal an intent to contend for the existence of additional dependent agent PEs in cases where no treaty protections are available. These changes may be disruptive without any clear benefits for investment in the UK; the previous criticisms of the revisions within the 2017 MTC (e.g., what is a “material modification”) are as relevant today as they were at the time. In this context, it is important to note that a failure to file for a PE may have additional consequences beyond those arising from a challenge to transfer pricing arrangements.
In conclusion, while the full impact of these changes will only become clear in time, taxpayers should review their positions and not assume these changes are minor and technical.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.