Following HMRC’s consultation issued in 2023 into the reform of the UK’s international tax framework, HMRC has now published draft legislation covering some changes to key international tax topics, including transfer pricing, the definition of permanent establishment, and the Diverted Profits Tax (DPT). 

These reforms aim to simplify UK tax law and align these areas with international standards. The earliest effective date for this draft legislation to become effective is 1 January 2026. In addition, they have published a new consultation relating to further changes to transfer pricing rules.

Transfer Pricing – draft legislation

The main change is that UK to UK transactions will be exempt from transfer pricing where no tax loss arises. This should be a welcome change to the transfer pricing landscape, in particular for wholly domestic groups. The UK-UK transfer pricing rules were brought in as a requirement of the UK’s EU membership, and are no longer necessary since the UK has left the EU. HMRC recognise that they can be administratively burdensome, without presenting a significant risk.

The other changes to the transfer pricing legislation relate to more technical points. These include a change to the ‘participation condition’ i.e. who is considered to be a related party for the purposes of the transfer pricing rules, and some changes to clarify that financial transactions should be priced in accordance with Chapter X of the OECD’s Transfer Pricing Guidelines and intangibles should be priced on an arm’s length basis where there are cross-border transactions between related parties.  

Transfer Pricing - consultation on scope and documentation

In addition to the above, HMRC have issued a new consultation on two more areas of transfer pricing.

1. The removal of the ‘Medium’ exemption, which would bring a huge number of SMEs into the transfer pricing rules for the first time;
2. The introduction of a new reporting form, called the International Controlled Transactions Schedule (ICTS), which will be required to be submitted annually alongside the UK corporation tax return

The rationale for these changes is that HMRC see the UK as an outlier amongst its peers in having an exemption for Medium enterprises, and they are of the view that most groups of that size with cross-border transactions are already having to consider transfer pricing to comply with the tax authority on the other side of such a transaction. In relation to the introduction of the ICTS, HMRC feel that this will collect data in an objective way which is standardised and will allow them to be more targeted in their approach to transfer pricing enquiries.

Permanent Establishments (PE)

There are proposed changes to the definition of PE to bring the UK legislation into alignment with Article 5 of the 2017 OECD Model Tax Convention. In reality, this will have limited impact in the short term, since, where there is an applicable double tax treaty in place, the definition of PE in the treaty will be relevant to a particular set of facts. The definition in the double tax treaties will not change with this change in UK domestic law. However, over time, as the UK re-negotiates double tax treaties then we would expect to see this updated wording in future double tax treaties as well. This has a slightly expanded definition of what activities can lead to a ‘dependent agent PE’, as included in the OECD’s Multilateral Instrument.

There are also some revisions to the Investment Manager Exemption, which is a targeted exemption from the definition of PE to stop overseas investors being brought into UK tax in relation to investment transactions.

Diverted Profits Tax (DPT)

There is to be a repeal of the standalone DPT regime and the tax will effectively be integrated into the corporation tax framework via a new charge on unassessed transfer pricing profits. This will allow taxpayers access to double tax relief via the double tax treaty network (whereas, previously HMRC held that DPT was not a covered tax). There has also been some simplification measures around the administration of the regime.

Next steps

The consultations relating to both the draft legislation and the transfer pricing scope and documentation remain open until 7 July 2025. We expect to hear an update on progress at the Autumn Budget. If you have any questions or would like to discuss how these proposed changes may impact your business, please get in touch with me, or speak to your usual Johnston Carmichael adviser.