On 19 June 2023, HMRC issued a consultation document covering three large areas of international tax legislation: transfer pricing; the taxation of permanent establishments; and Diverted Profits Tax.

There have been many changes in the wider international tax environment since the UK last made any major changes to these areas of UK tax law, so HMRC is considering making changes to bring these aspects of UK law into line, reflecting wider international tax developments. The intention is that the overall package of reform would be tax neutral, so it should not be raising additional revenue for HMRC.

Johnston Carmichael has submitted a response to the consultation, representing the views of our clients. Whilst the areas raised in the consultation are very broad, our views on the major questions likely to be of most interest are summarised here.  

Transfer pricing

In relation to transfer pricing, HMRC are considering whether UK to UK transfer pricing (i.e. where both parties to a transaction are within the UK) should be abolished. This has been in place since 2004, although HMRC have typically not strictly enforced it where there was no loss of UK tax. Nonetheless, as it was a technical requirement, clients have been concerned about getting it wrong leading to enquiries and potential penalties. We are in favour of the transfer pricing requirements being focused on cross-border transactions only, on the basis that the current rules are disproportionately burdensome for clients. Where both sides of a transaction are in the UK, it is rare for there to be any loss of tax if the transaction is mispriced. The other aspects of transfer pricing being reviewed include the rules that govern what is within scope in terms of the transactions and which parties are connected for these purposes (the participation condition). 

Taxation of permanent establishments

The questions regarding the taxation of permanent establishments (PE) (which is where a non-UK company has a taxable presence in the UK, equivalent to a branch) are aimed at making sure the UK legislation is fully aligned with the internationally agreed definition. The UK legislation was last updated in 2003 and there have been some changes to the definition used by the OECD (the Organisation for Economic Co-operation and Development) and other tax authorities globally, in particular in an effort to reduce base erosion and profit shifting. Any changes to the UK legislation would be unlikely to have much of an impact in the short or medium term, since the UK has double taxation treaties with over 130 countries and it is the definition of Permanent Establishment in the treaty which is important where one exists. Where there is no applicable double tax treaty, and in the longer run, as the UK re-negotiates its treaties, we could see an expanded definition of a dependent agent applying in the UK, to include wording around a person who ‘habitually plays the principal role leading to the conclusions of contracts’.

Diverted Profits Tax

HMRC are also planning to incorporate the Diverted Profits Tax (DPT) within the more general corporation tax rules. DPT was introduced as a separate type of tax to catch multinational groups that were purposefully avoiding UK corporation tax. HMRC feels that is has been successful in changing behaviours of these large groups and would like to keep it as a tool against tax avoidance. The aim of any reform is to re-write the DPT into the corporation tax legislation, instead of having it as a separate tax. In this way, it will be subject to the usual double taxation treaty protections, meaning that companies should not end up being double taxed if they suffer DPT in the UK.

In terms of next steps, HMRC will take some time to review the consultation responses and should then publish a summary of those. They are hoping to legislate any changes in the next Finance Bill, so we may see draft legislation later in 2023 or early 2024.

If you have any questions or would like to be kept up to date with this potential reform, please contact Amanda Collinson, Head of International Tax, or your usual Johnston Carmichael adviser.