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In a move that could significantly alter how multinationals structure their UK operations, the UK government has unveiled draft legislation proposing landmark reforms to its transfer pricing (TP) and permanent establishment (PE) rules while signaling the end of the country’s much-debated Diverted Profits Tax (DPT).
The proposals, published by HM Revenue and Customs (HMRC) on April 28, form part of a broader effort to modernize UK tax law and better align it with OECD standards and international practice. The government is seeking feedback by July 7, with legislation expected in the Finance Bill 2025-26 and the earliest implementation slated for January 2026.
Modernizing Permanent Establishment Rules
One of the most consequential changes is a redefinition of when a foreign business is considered to have a taxable presence or PE in the UK. The updated standard borrows language from the OECD’s 2017 Model Tax Convention, notably expanding the definition to include agents who “habitually play the principal role” in concluding contracts. The shift may raise the stakes for investment managers and others operating under exemptions that could now be reinterpreted.
While the UK’s existing tax treaties still reflect older, narrower PE definitions that will override the new domestic test, tax professionals expect the change to influence future treaty negotiations and increase scrutiny in cases without treaty protection.
Transfer Pricing Overhaul
The transfer pricing reforms cut across six key areas and could reshape compliance obligations for both inbound and outbound groups.
Among the most notable changes is the expansion of the “participation condition,” capturing common control arrangements even in cases where traditional ownership tests aren’t met. HMRC will also gain new powers to issue notices asserting TP conditions apply based on OECD principles.
Intra-UK transactions will generally be excluded from TP rules unless the companies involved opt-in or HMRC intervenes. That’s expected to reduce compliance burdens for domestic groups, although carve-outs for oil and gas and patent box transactions remain.
In the ever-contentious area of intangibles, the government plans to eliminate the dual valuation standard that has confused choosing to rely exclusively on the arm’s length principle for cross-border transactions.
Changes to the treatment of financial transactions, particularly the long-disputed concept of “implicit support,” are also poised to bring clarity. Under the new rules, only explicit guarantees will be subject to adjustment, which should reassure treasury functions and prompt reviews of existing debt arrangements.
The proposed International Controlled Transactions Schedule (ICTS) adds a new compliance layer, requiring standardized disclosure of related-party cross-border dealings. Companies with less than £1 million in such transactions may be exempt, but concerns remain over the cumulative compliance burden.
Diverted Profits Tax: Retired, Replaced and Recast
Perhaps the most headline-grabbing change is the proposed repeal of the UK’s 2015 Diverted Profits Tax, long criticized for its complexity and aggressive reach. In its place: a new charge under the mainstream corporate tax system, levied at a 31% rate on “unassessed” arm’s length profits where arrangements appear designed to reduce tax liabilities.
Though the headline tax rate and anti-avoidance flavor remain, the new mechanism drops the controversial concept of a “relevant alternative provision.” It streamlines the process into familiar transfer pricing terrain. The shift also removes the old “avoided PE” charge and the self-reporting requirement under DPT.
Looking Ahead
While these changes have been anticipated since HMRC’s 2023 consultation, tax advisers warn the details matter. The expanded PE test, broader TP powers, and the formal integration of OECD guidelines into domestic law signal an era of more aggressive enforcement and higher compliance stakes.
For multinational businesses, the message is clear: don’t wait for the final bill. Start reviewing transfer pricing policies, PE risk exposure, and cross-border structures now, or risk getting caught in the crossfire of HMRC’s modernization drive.
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