TP, PEs and DPT: consultation response

Update: For details of the further 2025 consultation response, see our article "Reform of transfer pricing, DPT and PE rules: consultation response".

HMRC has published its Summary of Responses to the consultation that it published on possible reforms to transfer pricing, permanent establishment (PE) and diverted profits tax (DPT) rules in June 2023. The proposed changes were largely put forward to modernise the UK rules, increase certainty and bring them more into line with international standards. More details of the original consultation can be found in our earlier Insights article.

On the basis of the responses received, the government will be taking forward some of the proposed reforms, whilst others will be subject to further consideration and consultation. In relation to transfer pricing, a number of changes will be introduced to the UK rules, most notably to the participation condition and the treatment of guarantees. However, other areas will be subject to further consideration.

In relation to PEs, the government will give further consideration to its proposal to align the UK definition with the OECD Model Article 5 and will also further consider its approach to its existing reservations on Article 5 in relation to future treaties. The UK attribution rules will, however, be brought into line with the OECD Model.

On DPT, the government will press ahead with its proposal to merge DPT into corporation tax.

Further consultations will take place during 2024 on draft legislation where the government moves ahead with its proposals.

Transfer pricing

Provision/conditions: respondents were divided on whether the UK legislation reference to “provisions” should be changed to match the OECD Model terminology, “conditions”. Whilst there was broad agreement that the terms are seen as analogous, there was concern that a change of terminology without an intended change in outcome may increase uncertainty. As a result, the government will give further consideration to whether the potential benefits of alignment outweigh the risks of unintended outcomes. Since the goal of alignment is to increase certainty, it is important that any change is not, in fact, counter-productive.

The participation condition: respondents generally preferred a definition of the participation condition that is prescriptive and exhaustive and opposed the use of less prescriptive terminology as being overly subjective and likely to increase uncertainty. To the extent that changes were necessary to catch other arm’s length scenarios not currently caught, respondents urged that any changes to the participation condition should b e done in a targeted manner.

The government’s response recognises that the current rules catch the majority of non-arm’s length scenarios, but reiterates the concern that there are exceptions. However, the government will address known problem areas with targeted and prescriptive rules to avoid increasing the compliance burden generally. More generally, there will be a review of the drafting of the participation rule more generally with a view to clarifying its application.

One-way street: respondents were generally clear on the purpose of the one-way street, but concerned over its application in practice. However, the government’s response makes it clear that it is an important aspect of the rules and there are no plans to significantly change it. This includes the requirement to apply it on a chargeable period by chargeable period basis (which can lead to unfairness). The rules intentionally require double taxation first before relief is given. If the chronology were reversed, there would a risk of non-taxation. However, the response does recognise the need for additional guidance in this area, including further communication on the ability of the UK to quickly provide relief in MAP scenarios.

UK:UK transfer pricing: responses made clear that UK:UK transfer pricing creates an unnecessary burden and it should only apply where there is a UK tax advantage. However, there was no consensus on how this should be achieved, some favouring a broad exception where a UK tax advantage exists, others a more prescriptive exemption where both entities are subject to the same marginal tax rates, subject to a specific list of exceptions. In response, the government has confirmed it will relax the obligation to apply UK:UK transfer pricing where the UK tax base is not disadvantaged. Further consideration will take place on how best to achieve this aim. However, the government will also include an opt-in to allow taxpayers to voluntarily apply UK:UK transfer pricing.

Guarantees: respondents generally supported proposals to redraft the existing rules around guarantees with new rules bringing UK domestic legislation more in line with the OECD model. As a result, the government will introduce a fixed rule to disregard the effect of guarantees on borrowings provided that the guarantee itself is within the transfer pricing rules (this will not always apply with UK:UK guarantees, therefore). Implicit support for borrowings will not be covered by this rule, but will issue guidance more generally on the application of the new legislation which will also cover the government’s views on the impact of implicit support.

Other valuation standards: there was general support for trying to align various valuation standards, such as the use of market valuation provisions in relation to intangible fixed assets and for transactions in capital assets for SMEs. However, the government remains concerned that there may be material differences between market value and an arm’s length price in some cases. The government will continue to consider the full impact of rules which would apply only the arm’s length price standard to transactions within the scope of transfer pricing, however.

Interaction with loan relationship and derivative contract rules and forex rules: the government remains committed to simplifying and clarifying the rules in this area and also recognises the need to consult further on any detailed changes.

Permanent establishments

Respondents to the consultation welcomed the broad aims of the PE reform to provide a simplified regime for MNEs and increase tax certainty for non-resident entities trading in the UK.

PE definition: on the subject of PE definition, if alignment with either the OECD Model or bilateral treaties was to be introduced, then there was no particular consensus on the best approach. As a result, the government will continue to consider whether to adopt the definition of a PE in Article 5 of the OECD Model in UK domestic legislation, favouring an approach that applies the OECD Model first, which would then be subject to the relevant treaty provisions. The government intends to consult again on any draft legislation that it proposes.

The main concern with adoption of the OECD Model centred on the potential expansion of the definition of a ‘dependent agent’ to include a person who ’habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without modification by the enterprise…’ and the additional restriction on exempting an agent who ’acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related’. This approach could result in more PEs being recognised and introduce additional complexity and uncertainty, which would result in further compliance burden for taxpayers in contrast to the stated aims of the reform.

Concerns were expressed that these changes would:

• lower the threshold for when certain non-resident companies are taxed in the UK where no double taxation treaty is in place and
• if subsequently reflected in UK treaties, lower the threshold for when UK resident companies are taxed overseas.

Several respondents referred specifically to the asset management sector as an area where the impact of the Article 5 changes might be more immediate. The concern is that increased uncertainty around the taxation of offshore funds might damage the UK’s competitiveness. This might lead to some investment management activities being moved offshore.

As a result, the response document notes that the government will continue to reflect on whether it should adopt the full Article 5 definition. A technical consultation will be held on any proposed changes. In terms of the UK’s future negotiating position on Article 5, the government notes that it will further consider its approach bearing in mind the concerns expressed in responses to the consultation. However, the document specifically notes that there will be no change to the UK’s existing reservations to Article 5 for the BEPS Multilateral Instrument and existing treaties would not be affected by any change of policy.

In relation to the asset management sector, there was significant concern that any changes to the scope of the PE definition would have adverse consequences, especially to the many fund managers which currently rely on agent of independent status exemption within an applicable double tax treaty. The government is cognisant of these concerns and the response document notes that there are ongoing discussions to ensure that any changes do not have unintended consequences for foreign investors in funds which are managed or advised upon in the UK. The government will consult with the sector to ensure that any reforms are implemented in a way that does not have an adverse impact. In particular, the response notes that a sub-advisor treated as an agent for the purposes of the PE rules will also be treated as such by the IME.

Attribution of profits: In respect of attribution of profits to PEs, respondents supported aligning UK domestic legislation with the relevant double taxation treaty or with Article 7 of the OECD MTC supported by the Commentary and AOA. The government will, therefore, hold a technical consultation on draft legislation to implement this reform, with consideration also to providing better guidance on how to apply the OECD commentary.

Income tax: the response acknowledges the potential mismatch with income tax rules where, in rare cases, a foreign company may become liable to income tax on the profits of a UK trade. However, whilst noting that it might be preferable to remove this inconsistency, no specific examples of problems in practice were provided and the government regards this issue as outside the scope of the consultation.

Diverted profits tax

The majority of respondents welcomed the proposal to remove DPT’s status as a separate tax and bring it within the corporation tax framework. It was welcomed as a simplification and improving certainty in relation to access to treaty relief. The proposal to remove the avoided PE aspects of the rules was also welcomed and the response notes that these reforms will be taken forward. More generally, however, the government has noted that it continues to see the DPT rules as important, but will continue to keep the need for the regime under review in an evolving international tax landscape, including following the introduction of the Pillar 2 rules which may provide an opportunity to introduce further simplifications to the UK tax rules and reduce the compliance burden. Further information on the administration of the reformed DPT will be set out in a further technical consultation. This will include how a DPT assessment will interact with MAP.

The consultation response also includes the government’s response to various detailed technical changes it proposed to the DTP rules and it will set the proposed changes out in draft legislation in a forthcoming technical consultation.

Next steps

The response notes that the government will now put forward its detailed proposals in draft legislation and will hold a technical consultation on this draft consultation in 2024. No timeframe is given at this stage, but it is to be hoped that, given the complexity of some of the issues, this will be later in the year rather than rushed through in time for a summer Finance Act.