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United Kingdom - Reform of the UK’s international tax laws: a step closer

This article was orignally published in Tax Journal on 23 February 2024 and can be found here: Reform of the UK’s international tax laws: a step closer (

Speed read

Against the background of Pillar Two implementation and the new compliance burdens it brings, it is good news that the UK government is seeking to improve and streamline domestic tax law affecting multinational enterprises. The proposed reforms to the UK’s transfer pricing (TP), permanent establishments (PE) and diverted profits tax (DPT) rules are mostly at the detailed level, rather than making seismic changes. While many of the reforms will bring welcome simplifications, businesses and their advisers will need to look out for any knock-on effects that the final changes trigger.

On 16 January 2024, HMRC published a summary of the responses to the June 2023 consultation on potential reforms to the UK’s transfer pricing (TP), permanent establishments (PE) and diverted profits tax (DPT) rules. While the government’s comments on the responses are not conclusive in many areas, they give a useful insight into policy thinking and the complexities still to be addressed before draft legislation is published.

The reforms aim to modernise the UK’s domestic rules by clarifying the application of TP, PE and DPT, while ensuring the outcomes they achieve remain consistent with the government’s policy intention, international standards and the UK’s tax treaties. HMRC also see an opportunity to:

  • improve fairness: ensuring MNEs pay tax on profits generated from economic activity in the UK;

  • simplify existing rules: so that legislation is easier to understand; and

  • support growth: improve tax certainty and continued access to treaty benefits, thereby promoting inward investment.

Transfer pricing proposals

Making the TP rules simpler, more certain and better aligned with tax treaties will bring changes to both the core TP rules and their implementation in other parts of tax law.

1. Bringing the concept of ‘provision’ closer to the OECD model treaty concept of ‘conditions’: The driver for this part of the reforms is to resolve a perceived ambiguity caused by differences in terminology. Although HMRC say ‘respondents were divided as to whether change is necessary’, a notable number of respondents did welcome alignment in terminology. Despite the government’s undertaking to ‘weigh the benefits of alignment against potential unintended consequences’, arguably, the intention to align the meaning of ‘provision’ with the phrase ‘conditions made or imposed’ is already clear in existing legislation (TIOPA 2010 s 164), the Explanatory Notes to Finance (No. 2) Bill 1998 and HMRC’s International Manual at INTM412050.

2. Making the ‘participation condition’ easier to apply: The current ‘participation condition’ test was seen as formulaic and prescriptive by most consultation respondents, so that some non-arm’s length scenarios will inevitably be missed. The government recognises this, but it is not keen on making the test prescriptive and exhaustive, as exceptions could lead to significant loss to the Exchequer. Instead, to address the uncertainty that the current rules create, it plans to ‘address known problem cases’ through amendments to the legislation to focus on the scenarios for which it was primarily devised.

3. Making the ‘one-way street’ easier to understand and apply: The government considers that the ‘one-way street’ provision (which ensures that TP adjustments can only increase revenue collected in the UK) is an important aspect of UK TP rules, and consistent with the approach of other jurisdictions. It will not be abolished, but applying it can be complex, so the need for additional guidance is acknowledged.

The annual basis of taxation is the key driver for a chargeable period by chargeable period application of the ‘one-way street’. The government agrees the current rules could potentially lead to outcomes taxpayers consider unfair, e.g. differences in accounting standards may affect the timing of revenue recognition and the treatment of expenses in arriving at profits, leading to a disallowance in expenses because of the timing difference.

The government accepts that the ability of the UK to quickly provide relief from double taxation in Mutual Agreement Procedures may not be fully understood. More HMRC guidance, including examples, is promised.

4. Exemption for UK/UK transactions: To reduce compliance burdens, the obligation to apply TP between UK entities will be relaxed in situations where the UK tax base is not disadvantaged. However, taxpayers will be permitted to opt into UK TP voluntarily. The government is also considering whether an exhaustive and specific list of exceptions to the exemption is practical, without compromising its aim of simplification.

5. Commissioners’ sanctions: Most respondents agreed that Commissioners’ sanctions (required from HMRC’s TP policy team before a TP determination) do not provide significant assurance or value beyond HMRC’s existing risk governance processes. So, the government will remove the legislative obligation for Commissioners’ sanctions and has tasked HMRC with considering how its existing safeguards and processes can be adapted.

6. Treatment of loan guarantees: There have been concerns over potential overlap of the rules since the OECD’s Transfer Pricing Guidance on Financial Transactions was adopted into UK guidelines. So, the government will replace TIOPA 2010 ss 152-154 with a fixed rule which disregards the effect of guarantees (but not implicit support) on the amount of debt - but only where the provision of the guarantee is within the scope of TP.

To address the potential disadvantages to taxpayers caused by the proposed repeal of TIOPA 2010 ss 191-194, the government will retain current s 192 relief (for guarantors to claim borrower’s disallowed interest). It will also ensure that certain UK-resident companies that have not provided a formal guarantee can continue to make such claims. Transitional rules may be needed for existing debt.

7. Intangibles - arm’s length price versus market price: The government agrees with the majority of respondents who preferred the use of a single arm’s length price standard, rather than market value, and will retain it for intangible transactions (increasingly important for MNEs), despite suggestions to abolish it. However, it is still considering whether to allow the ability to adjust valuations in both directions (even though contrary to the ‘one-way street’ principle). It will also assess whether special situations, such as where an asset is exchanged for non-monetary consideration, can be dealt with in targeted legislation.

8. Interaction with other tax rules: The government recognises the complexity inherent in the interaction between TP and the loan relationships and derivative contracts regime, and proposes to simplify and clarify these rules, but does not currently intend to repeal CTA 2009 s 444. Similarly, adjustments to foreign exchange movements gains and losses will be simplified by bringing them within the direct ambit of TIOPA 2010 Part 4, but matching rules for exchange gains and losses will remain. We are pleased to see that many responders’ comments, including BDO’s, have been taken on board, and promised simplifications, after further consultation, will reduce compliance burdens.

Permanent establishments
The proposed reforms could alter the basis for taxing UK activities of non-UK resident companies by changing the definition of a UK PE and the profit attribution rules in one of two ways: aligning more closely with either tax treaty definitions or with the OECD model treaty. Either way, the existing exemptions from PE status for UK brokers and investment managers will be maintained.

If the OECD model treaty approach is taken, this may involve adopting from the BEPS project the definitions of dependent agent’ and ‘independent agent’. This is expected to include the OECD definition of a ‘person who habitually plays the principal role leading to the conclusion of contracts’ but excludes an independent agent who ‘acts exclusively or almost exclusively’ for related parties.

Respondents to the consultation were, broadly, in favour of a simplified regime for MNEs and increasing tax certainty for non-resident entities trading in the UK. On specific points, they also supported simplifying the process of attributing profits to PEs by closely aligning it to the OECD’s Report on the Attribution of Profits to PEs (the Authorised OECD Approach, ‘the AOA’). However, concerns were expressed about changing the definition of a UK PE – particularly on the potential expansion of the definition of dependent agency, but also the definition of independent agent: the asset management sector is concerned that this might damage the UK’s competitiveness.

Respondents said alignment with article 5 of the model treaty would lower the threshold for:
  • companies resident in territories with which the UK does not have a relevant tax treaty;
  • other non-resident entities, if the changes were subsequently reflected in UK treaties; and, arguably most significantly,
  • UK-resident companies operating overseas.
The government has said that it will continue to consider whether to adopt the definition of PE contained in the model treaty, and will hold discussions with stakeholders in the asset management sector. A key question is why, after reserving against the change to the definition of ‘dependent agent’ as part of the BEPS Multilateral Instrument, the government is now proposing to adopt the definition.
Diverted profits tax

Those responding to the consultation had a marked appetite for any new rules to clarify the way in which diverted profits will be taxed. The government’s comments are light on detail, but some points give a clear steer of the likely changes:

  • DPT will be brought within corporation tax (and thus subject to its enquiry framework) but will continue to be a ‘stand-alone’ charge.

  • Disappointingly, there seems to be no appetite to consider alignment with the Pillar Two rules now, so, at least technically, a diverted profits charge could arise even where the relevant profits are already subject to a Multinational Top-up Tax (MTT) or Qualified Domestic MTT charge.

  • The charge will no longer apply to foreign companies with an ‘avoided PE’, but will instead be modified to charge the relevant UK persons.

  • Loss-making companies will not face a cash tax charge, but ring-fencing of losses will aim to ensure that taxpayers do not benefit from diverting profits overseas.

  • It appears that the ‘effective tax mismatch outcome’ and ‘insufficient economic substance condition’ tests may be modified but not replaced.

  • The rules for evaluating the amount of diverted profits will be more closely aligned to the TP arm’s length principle.

  • The government will allow HMRC assessments to be based on ‘best evidence’ where, in certain cases, the legislation has set out a formula for an initial charging notice.

  • Similarly, amendments will in future be possible where new information comes to light during an enquiry. This is not currently possible until the initial 12-month period had elapsed.

While there is no appetite to do away with the diverted profits regime altogether, the changes should prove welcome, but much will depend on the detail of the final legislation.

Next steps
Draft legislation will be published in summer 2024, with a technical consultation to follow. There is currently no specific timetable for implementing changes, but if they do eventually provide greater certainty, help in the settlement of Mutual Agreement Procedures, and enhance the attractiveness of the UK, then they will be greeted enthusiastically. However, given the complexity of the areas under discussion, all stakeholders will need to be vigilant to ensure the reforms do not cause collateral damage along the way.

If you have any questions, please contact the author(s) or reach out to one of our Global Transfer Pricing professionals

Meenakshi Iyer
Joel Kara
BDO in United Kingdom
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