Transfer pricing: UK Government Spring 2025 consultation

There are a number of proposed changes to the UK’s transfer pricing rules:

1 The participation conditions need to be met for the UK transfer pricing rules to apply. They determine whether entities are related or connected for transfer pricing purposes. Three changes are proposed which the Government thinks will clarify the handful of scenarios where the current legislation is not clear.

2 The draft legislation will exempt domestic (UK:UK) transactions between companies in scope of transfer pricing where there is no risk of tax loss. The exemption, as drafted, only applies to companies subject to corporation tax, provided each entity is subject to corporate tax at the same rate and uses the same currency. A list of scenarios where the UK:UK exemption won't apply has also been listed. These include if an entity is party to the Patent Box and certain financial instruments that give rise to asymmetrical tax treatment.

3 When valuing intangibles taxpayers often have to consider both the market price and the arm’s length price due to the interaction of Part 8 Corporation Tax Act 2009 and the transfer pricing legislation. The draft legislation intends to simplify the current rules and reduce the compliance burden by requiring one valuation standard to be applied. The arm’s length price will be used for all cross-border transactions between related parties that are in the scope of the transfer pricing legislation, and the existing market value rules will be retained for all other scenarios where a transfer of assets is within the scope of UK tax legislation.

4 The requirement for HMRC’s commissioners to sanction transfer pricing determinations has been removed.

5 It's clarified that the UK’s transfer pricing legislation should be interpreted in accordance with OECD principles and that the OECD Model Tax Convention and OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD guidelines) are interpretive aids regardless of whether there is a tax treaty in place.

6 Financial transfer pricing is a complex area of transfer pricing. The Government has therefore issued draft legislation that intends to:

• align the UK rules for guarantees with the guidance in Chapter X of the OECD guidelines
• clarify the acting together rules and compensating adjustments
• amend specific aspects of the interaction between the loan relationships and derivative contracts
• simplify the rules on the tax treatment of foreign exchange gains and losses.

Our view

The suggestions made are in line with comments received by HMRC under the 2023 consultation. This demonstrates that the Government has listened and is committed to reducing ambiguity for taxpayers and to simplify and update the UK international tax legislation.

The exemption of most domestic transactions from the UK transfer pricing legislation is welcome and will align the UK with its international peers, as well as reduce taxpayers’ compliance burden. Care is needed to ensure that the exemption will apply.

The Government proposes to bring the UK's permanent establishment rules into line with the latest international consensus on the definition of a permanent establishment and the attribution of profits to a permanent establishment. The reform doesn't affect the content or operation of any of the UK's double taxation treaties. It will, however, clarify which supporting guidance and materials can be used in conjunction with the UK legislation to determine questions around permanent establishments. This includes references to the 2010 OECD Report on the Attribution of Profits to Permanent Establishments and aligning the definition with the 2017 OECD Model Tax Convention.

Previously, the domestic test for a dependent agent permanent establishment (DAPE) was whether "an agent has and habitually exercises their authority to do business on behalf of the company". The new test is whether "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".

The Government considers that a person who meets this new definition would also fall within the previous wording, which is very broad in scope. Additionally, any treaty definition would remain unaffected by this change. Therefore, the legislation has been drafted based on the 2017 OECD definition. Note that the revised draft permanent establishment legislation doesn't match the wording in the OECD Model Tax Convention verbatim. This is to preserve the possibility, under UK common law, of a dependent agent arising in a case where either the agency or the principal is undisclosed.

The Government also proposes to amend the Investment Manager Exemption (IME) legislation to ensure it remains fit for purpose. It will also update Statement of Practice 1/01 which provides guidance on how to interpret the IME.

Our view

The alignment with OECD definitions and specific reference to OECD commentary will likely reduce disagreement and possible disputes. As such this can only be seen as positive for businesses.

How the adaptation of the definition of a DAPE will apply in practice will be interesting. ‘Habitually playing the principal role leading to the conclusion of contracts’ is broad, subjective, and could lead to lengthy evidential enquiries to resolve, which contradicts the intent with the alignment with OECD commentary. Arguably though, so was the previous language of ‘authority to do business’.

The new DAPE wording may also only have a narrow impact given the UK’s extensive treaty network, which means that the treaty takes precedence rather than the underlying domestic legislation.

The proposal is for the creation of a new charging provision for unassessed transfer pricing profits (UTPP) within corporation tax, which will retain the essential features of the DPT regime and withdrawal of DPT as a separate tax.

This will clarify the relationship between the taxation of diverted profits and transfer pricing, as well as providing clearer access to treaty benefits. The approach would enable businesses to benefit from the UK's treaty network features, such as access to the mutual agreement procedure (MAP) to remove double taxation.

There will be no specific UTPP notification regime and corporate tax will be charged at the UTPP rate on UTPP, instead of the main rate or any other rate. A UTPP assessment could be issued with or without a corporate tax notice of enquiry. Payment of the UTPP assessment can't be postponed on any grounds except for tax suffered on the same profits. And no reliefs deductions or set offs can be made against the UTPP assessment.

The UTPP assessment process would mirror the DPT regime. Two gateways must be met for UTPP to apply:

• The effective tax mismatch outcome (ETMO)
• The tax design condition (TDC)

The ETMO would be met for a provision between a company and a related party for an accounting period if the corresponding amount is less than 80% of the amount of corporate tax that would be charged on the profit to which the UTPP relates.

The TDC is a single test. It would be met if it's reasonable to assume that the structure of the provision to which the UTPP applies, or if the structure of arrangements of which the provision forms a part, is designed to have the effect of reducing, eliminating or delaying the liability of any person to pay any tax (including non-UK tax).

Our view

The changes being recommended to the DPT legislation are largely positive, particularly bringing these principles into corporation tax.

Our concern would be whether the UTPP truly aligns itself with transfer pricing. The Government remains committed to the upfront payment of tax and higher penal rate. Yet the same challenge could be raised using transfer pricing principles without the need for these rules.

The TDC is very broadly worded. While it reduces the analysis to a single test, the test itself hinges on whether HMRC believes it reasonable to assume that there was tax motive in the design of the arrangements. This wording increases the risk of subjective challenge and may increase disagreements with taxpayers rather than reduce them.

The continued use of the ETMO shows that the Government still believes it must target taxpayer motives where reduced tax rates (in any form) are part of the decision-making process. 

With the introduction of Pillar Two and a global minimum effective tax rate, this could be argued to negate the need for such testing – although this isn't an area the Government explores in this consultation.

It's unclear how the UTPP will align with the MAP process. Bringing these principles into the corporation tax regime means treaty access, and therefore MAP coverage. However, a UTPP assessment from HMRC wouldn't yet feature in a corporation tax return and so clarity is required as to how HMRC would issue an assessment for UTPP that could trigger a MAP process without requiring the taxpayer to self-assess HMRC’s position.