Consultation outcome

Summary of responses

Updated 16 January 2024

Introduction

The proposed reforms to transfer pricing, permanent establishment (PE) and Diverted Profits Tax (DPT) are intended to modernise the UK’s domestic rules. The reforms will ensure that the application of these rules is clear, and the outcome of their application remains consistent with the policy intention, international standards, and the UK’s tax treaties.

The reforms are an opportunity to:

• improve fairness: ensuring multinational enterprises (MNEs) pay tax on profits from economic activity in the UK in the same way as other businesses
• simplify existing rules: aiming to develop simpler legislation that is easier to understand
• support growth: improving tax certainty and continued access to treaty benefits, thereby promoting inward investment into the UK

On 19 June 2023, the government published a consultation document asking for views on the reform proposals Reform of UK law in relation to transfer pricing, permanent establishment and Diverted Profits Tax - GOV.UK (www.gov.uk). The consultation closed on 14 August 2023.  

The government is grateful to all those who responded to the consultation. The proposals were broadly welcomed by respondents, although some areas of concern were noted. The government has considered the responses and will take them into account in the development of these proposals. The government will hold a technical consultation on draft legislation in 2024.

Executive Summary 

The government is developing a package of reforms to 3 elements of UK international tax legislation: transfer pricing, permanent establishments, and Diverted Profits Tax. The aims of these reforms are to modernise and simplify these rules, in order to improve tax certainty and alignment with treaties.

Which rules are being considered?

Transfer pricing rules: The transfer pricing rules require that, in calculating profits subject to Corporation Tax (CT) and Income Tax, transactions between connected parties should be priced on terms that would be expected if the transactions had been carried out under comparable conditions by independent parties.

This is an internationally recognised principle that is reflected in many of the UK’s double taxation treaties. This helps to ensure profits are taxed in the countries where activities giving rise to those profits are undertaken.

Permanent establishment (PE) rules: CT is charged on the worldwide profits of UK resident companies, and the profits of non-UK resident companies insofar as they relate to activities carried on in the UK through a PE. This is an internationally recognised standard. It is reflected in the UK’s double taxation treaties and is designed to ensure that countries only tax companies with a sufficient level of activity.

Diverted Profits Tax (DPT): Introduced in 2015, DPT is a targeted measure that counters contrived arrangements designed to avoid profits being taxed in the UK. It is currently a standalone tax, though it borrows many of the principles of the transfer pricing and PE rules.

If engaged, tax is charged upfront at a higher rate than CT. The procedural rules have also successfully addressed the information imbalances that can otherwise exist between HMRC and taxpayers in complex and long running transfer pricing enquiries.

All of these rules are important for HMRC as they seek to ensure that the appropriate amount of profit is taxed within the UK. They are also important to taxpayers who seek to get their tax affairs right.

This is because the division of taxing rights across different jurisdictions can give rise to double taxation. The principles underpinning these rules which govern the allocation of profits between jurisdictions are based on internationally agreed standards.

Summary of proposals

The consultation raised a number of questions to ensure that, in considering these proposals, the government has a full understanding of respondents’ views and experiences.

Transfer pricing

The government is proposing changes to transfer pricing legislation to make the rules simpler, more certain and better aligned with tax treaties. The changes will affect both the core transfer pricing rules and their implementation in other parts of tax law.

Permanent establishments

The government will continue to consider whether to align the UK domestic definition of a PE with the definition set out in Article 5 of the 2017 OECD Model Tax Convention (MTC) in light of stakeholder comments.  

Regardless of whether those changes are made, the Investment Manager Exemption (IME) and Independent Broker Exemption (IBE) will be retained. However, the government will consider whether changes are needed to clarify the operation of the IME and IBE.

In addition, the government will revise the current domestic legislation on PE attribution contained in Chapter 4 of the Corporation Taxes Act 2009 (CTA 09) so that it aligns with Article 7 of the OECD MTC. This will be supported by the Commentary and the OECD Report on the Attribution of Profits to PEs (AOA).

Diverted Profits Tax

The government will remove DPT’s status as a separate tax and bring an equivalent charge into CT. This will clarify the relationship between the taxation of diverted profits and transfer pricing. It will provide access to treaty benefits while maintaining key features of the regime.

Responses

This document sets out a summary of responses received in respect of the consultation.

The government held 4 public meetings involving over 300 people and received 43 written responses from businesses, agents and representative bodies. The government is grateful for the helpful and constructive feedback received, with many respondents making detailed comments on the proposed reform. The responses have helped HMRC to understand respondents’ views and concerns.

We have summarised the views of respondents in this document. They will be used to inform the further development of these proposals.

Transfer Pricing

General responses

Respondents welcomed the intention of the consultation, to clarify, simplify and improve the current rules. There was support too for the effort to improve alignment between domestic law, and the OECD MTC and OECD Transfer Pricing Guidelines (TPG).

It was observed that care should be taken to ensure that adverse consequences are avoided. To that end, many respondents urged the government to consult on draft legislation should any of the proposals be taken forward.

Respondents were not supportive of radical change to the participation condition. Some believe that the current rules provide sufficient coverage and certainty. Others see benefit in consolidating and clarifying those rules where possible.

There was some recognition that the current rules may not catch all related party transactions. However, this was accompanied by a strong preference to address specific problem cases with targeted, prescriptive rules as opposed to less prescriptive factual tests.

Respondents called for additional supplementary guidance, both in relation to existing rules which are to be retained and where legislative change is made.

Question 1: The government welcomes respondents’ views on the term ‘provision’ within s.147 of the Taxation (International and Other Provisions) Act 10 (TIOPA). Specifically, is this term commonly understood, does it provide anything more than ‘conditions’ per Article 9 of the OECD Model, and do respondents encounter any practical difficulties which result from the difference in terminology between UK domestic law and the Treaty?

Some considered that ‘provision’ might be interpreted differently from ‘conditions’ in Article 9. However, the large majority noted that the terms are well understood to be analogous.

Some noted that, although ‘provision’ is not itself defined, it is clearly linked to ‘transaction or series of transactions’ which is in fact well defined. However, they also noted that the scenarios in which it is proper to look past an individual transaction to a series are not entirely clear.

Respondents were divided as to whether change is necessary. Some thought that it would resolve ambiguity caused by differences in wording between Part 4 and Article 9, even if such a change had no material effect on the outcome. Others suggested that the act of making a change itself might cause uncertainty. Reasons cited were that it could suggest that there is a difference between the two currently and that it would lose the benefit of existing precedent.

Some suggested that, regardless of the term adopted, it will be important to retain an ability to look at the overall single economic arrangement between two entities. This is currently made possible via the ‘series of transactions’ language.

Some respondents highlighted difficulties with the application of a ‘two persons’ test to multilateral arrangements involving more than two persons.

Some asked for further guidance, particularly with regard to the relevance of para 3.9-3.17 of the OECD TPG (combined transactions and intentional set offs).

Some noted the important task of ensuring that other areas of UK legislation which use the term ‘provision’ are consequentially updated.

General responses

The government’s driver for the proposed reform to the language in s.147 TIOPA was to resolve a perceived ambiguity caused by differences in terminology. The common theme from responses is that, if such an ambiguity might theoretically exist, it doesn’t cause practical problems in the majority of cases.

The intention for alignment between the two is made clear at:

1. s.164 TIOPA
2. Explanatory Notes to Finance (No.2) Bill 1998
3. HMRC’s guidance at INTM412050

The government acknowledges respondents’ concerns that a change in terminology without an intended change in outcome could increase uncertainty. However, a notable number of respondents did welcome alignment in terminology, and observed that there might be edge cases in which the difference has a practical effect.

The government will consider whether the potential benefits of alignment outweigh the risk of unintended outcomes. The goal with alignment is certainty and the government does not wish for any change in this area to be counterproductive.

Question 2: The government welcomes respondents’ views on the participation condition, and experiences of the application of other jurisdictions’ laws in that regard.

Most respondents who commented on the current coverage of the participation condition agreed that for the most part it is a formulaic and prescriptive test. Therefore, it will inevitably miss some non-arm’s length scenarios.

There was some acceptance of the rationale behind exploring options to ensure better coverage of those scenarios. However, most consider that the current test catches the vast majority of non-arm’s length transactions. They urged that any alteration to catch exceptions should be done in a targeted manner which does not excessively burden all taxpayers.

Most respondents preferred a definition of the participation condition which is prescriptive and exhaustive. Some suggested that the existing rules are generally well understood by taxpayers, and that the prescriptive definition provided by the legislation improves certainty.

Respondents generally opposed the use of less prescriptive terms (for example ‘acting in concert’, ‘community of interest’ or ‘special relationship’). Those terms were considered to be overly subjective, would decrease certainty and increase the compliance burden. Some suggested guidance could increase certainty, though others did not think that guidance would overcome these issues.

Some respondents emphasised the need to distinguish between commercial bargaining power and informal control/influence which constitutes a non-arm’s length relationship.

Most respondents agreed that aspects of the current participation condition are complex, in particular the rules relating to indirect participation. Some respondents referenced the ‘acting together’ rules (s.161 and s.162 TIOPA10) as being particularly difficult, as the term is undefined and requires subjective assessment of the relationship between parties. There was strong support for simplification here.

A potential downside of the current formulaic rules was identified by some respondents. In relation to joint ventures, respondents noted that a formulaic rule may catch arm’s length transactions. This is because it doesn’t allow for a more nuanced view of the relationship between two persons.

Some agreed that a failure to be caught by a prescriptive participation condition does not define a transaction as arm’s length. However respondents were split on whether all transactions in that category are suitable comparators. Notwithstanding that, this is an area of uncertainty in which most respondents would like to see additional guidance.

Many respondents offered their experiences of other territories’ rules on participation. Respondents were split on whether the UK’s participation condition is more restrictive. The following observations were made:

• Respondents generally considered that even in territories which use the concept of de facto or informal control (notably the US and Canada), the participation condition was, in practice, applied in the same way as in the UK
• Some respondents suggested that complex disputes regarding whether the participation condition is met have arisen in territories which apply a more flexible participation condition
• One respondent noted the Danish rules may apply more broadly than the UK rules in applying to entities with ‘common decisive power’ between shareholders or directors
• Some aspects of indirect participation, in particular the “acting together rules”, make the UK rules broader than many treaty counterparts

Many respondents noted that the participation condition as defined in Part 4 TIOPA is referenced in other areas of legislation. Any change to the definition would need to be considered in that context. Some respondents suggested that the definition of control should be unified across all areas of legislation.

Some respondents suggested that HMRC may introduce a power to issue a notice to taxpayers to deem the participation condition as being met.

Those respondents considered that this might alleviate the government’s concerns about the prescriptive nature of the participation condition, whilst still ensuring taxpayer certainty at filing. Some respondents suggested that such a notice could be introduced as a targeted anti-avoidance rule.

Regardless of whichever option is pursued, most welcomed additional guidance.

Government response

The government welcomes respondents’ comments regarding the participation condition.

The government acknowledges that the current formulation of the rule catches the majority of non-arm’s length relationships between two persons. However, there are exceptions, which can lead to significant loss to the Exchequer in individual cases.

Balancing coverage with compliance burden is important, and the government is committed to achieving that balance. The government will address known problem cases in a targeted and prescriptive manner. In doing so, the government will seek to avoid materially increasing the compliance burden more generally for taxpayers without those specific fact patterns.

The government also acknowledges that the current rules are in places broad and can produce uncertainty. The government will amend the legislation to better target it on the scenarios in respect of which they were primarily devised.

The government will clarify other existing rules within the participation condition.

Question 3: The government welcomes respondents’ views on the ‘one-way street’: how frequently do tax disadvantages arise, and do taxpayers commonly amend underlying contracts to avoid the unfavourable outcomes? Is the purpose of the ‘one-way street’ fully understood and how does it compare with comparable rules in other jurisdictions? How does the ‘one-way street’ factor in commercial decision making (if at all)?

All respondents understood the general policy aim of the ‘one-way street’. There was a common understanding that it seeks to avoid double non-taxation. However, many respondents felt that the specific application of the ‘one-way street’ in practice is not well understood and therefore further guidance would be particularly helpful in this area.

Respondents generally thought that the ‘one-way street’ does not impact commercial decision making. However, they noted a perceived unfairness in its application to provisions which span multiple periods, or where the same entity is subject to multiple provisions.

Some noted that Article 9(1) is written in terms which permit only additions to profits which are otherwise understated due to the ‘special relationship.’ Article 9(2) provides the mechanism for relief from any double taxation which consequentially arises.

Some questioned the need for the test to operate on a chargeable period by chargeable period basis, noting that Article 9 itself doesn’t reference chargeable periods. There were requests for some ability to take account of mispricing in later years which reversed tax advantages in earlier ones.

Some respondents asked for clarification regarding specific scenarios. A few noted that accounting rules, and differences in standards between entities, can lead to the recognition of amounts in different periods.

More generally, respondents noted that exposure to adverse effects can be unavoidable. For example, taxpayers can’t always ensure that underlying contracts align with arm’s length outcomes. Nor can they guarantee that, where there is alignment, the underlying transfer pricing policy won’t be challenged. The potential for the Mutual Agreement Procedure (MAP) was noted, though so too was the fact that MAP is not always available in every case.

Some considered that pragmatism, flexibility and guidance would be useful in the absence of any legislative change in this area. Others suggested specific mechanisms to provide relief outside of MAP – for example:

• The ability to set off negative adjustments from positive ones provided the overall outcome is an addition to profits or reduction in losses
• A route for unilateral relief in the UK without a MAP claim
• The ability to file on the basis of revised conditions subject to the resolution at MAP
• An HMRC power to exercise discretion to permit negative adjustments

Some asked for additional information about the mechanisms available to taxpayers to resolve double taxation. In particular, they wanted further detail on the circumstances in which the UK would provide unilateral relief, if any, or where MAP might be expected to be resolved quickly. The common perception is that MAP is a lengthy and burdensome process.

One respondent suggested that the government should seek to abolish the ‘one-way street’ entirely. Their view is that it no longer proportionately serves its purpose in the modern tax environment.

Government response

The government welcomes respondents’ views on the ‘one-way street’. Despite broad understanding of its core purpose, its application in specific cases can be complex. The government acknowledges that it can have the potential to lead to outcomes which might, on a unilateral perspective, be considered unfair by taxpayers.

However, the government still considers the ’one-way street’ an important aspect of the UK transfer pricing rules, and consistent with the approach taken by most treaty partners. The government therefore has no plans to abolish or significantly alter it.

The government sees a need for additional guidance in this area, which should include certain examples to draw out some of the permutations. The government is grateful for the specific examples offered and will consider those further.

S.147(3) and (5) impose the arm’s length provision. They do so only in those circumstances where the failure to price the actual provision on arm’s length terms has resulted in a potential tax advantage in a chargeable period.

S.155 defines potential advantage in terms of profits or losses taken for tax purposes. As one respondent noted, this is the reverse of the more general commercial ‘advantage’ of increased profits or decreased losses. The government accepts that this might cause some confusion for those not well versed in the rules, and will consider this further.

The main purpose of UK transfer pricing is to protect the Exchequer from the adverse impact of mispricing of transactions which otherwise depresses taxable profits. The rules need to achieve this on an annual basis in a manner which does not frustrate the objective of treaties, being the avoidance of both double taxation and non-taxation.

The annual basis of taxation is the key driver for a chargeable period by chargeable period application of the ’one-way street’. The example provided at 3.2 of the consultation explains how non-taxation could result on a net outcome application. There are also practical difficulties in determining the correct tax outcome in an earlier year before the ultimate effect of mispricing across the term is known.

As one respondent noted, the chronology of adjustments set out in Article 9 broadly reflects the UK rules:

• Article 9(1) permits a state to make an adjustment to profits to include amounts which would have arisen in the absence of the special relationship
• Article 9(2) requires the other state to make a corresponding adjustment to profits, having regard to other Articles such as Article 25 which provides for MAP

This intentionally requires double taxation first before relief is given. If the chronology were reversed there would be no incentive for a taxpayer to file on a consistent basis in the counterparty territory. This is the natural effect of unilateral negative adjustments which do not require a corresponding positive adjustment.

This would lead to a significant risk of non-taxation. In other words, the chronology of primary positive adjustment followed by secondary, relieving (or corresponding) adjustment best ensures the avoidance of non-taxation, whilst still permitting the resolution of double taxation via the treaty.

Some respondents highlighted that a MAP claim requesting relief in the UK for an adjustment in another territory may be accepted by the UK competent authority with limited, or no, further work.

This will be possible where the information provided is sufficient to demonstrate that the adjustment being sought is consistent with the arm’s length principle (ALP). This would be of particular likelihood in a scenario where the UK has assessed based on that treatment in another year.

The government accepts, however, that the ability of the UK to quickly provide relief from double taxation in MAP with limited further work may not be fully understood. The government will consider further communication on this including examples as to when it will be appropriate.

Question 4: The government requests respondents’ views on UK:UK transfer pricing. Is it onerous and to what extent, and would providing a general exemption materially reduce the compliance burden? Do respondents have any views on the practical application of a general vs specific exception to the general exemption?

Respondents considered the application of transfer pricing rules to UK:UK transactions creates an unnecessary compliance burden on business relative to the risk to the Exchequer.

Respondents generally recognised the need for UK:UK transfer pricing rules to apply in situations where there is a UK tax advantage, for example through rate arbitrage.

Respondents were split regarding how an exemption from UK:UK transfer pricing should be given effect. Some favoured an exception where transfer pricing only applies where there is a UK tax advantage. Others want a more prescriptive exemption where both entities are subject to the same marginal rate of tax, subject to a specific list of exceptions.

Some respondents thought that a list of specific exceptions to UK:UK transfer pricing could be more complex, and prone to ongoing change, reducing simplicity and certainty.

Others considered that a list of specific exceptions would provide greater certainty to taxpayers. These respondents referenced specific exceptions already provided for in legislation, such as The Transfer Pricing Records Regulations 2023.

Some respondents noted that a general exemption subject to a UK tax advantage rule should be subject to guidance. This should explain when HMRC considers there to be a UK tax advantage, materiality, and the evidence required to support a position.

A few respondents suggested that an option for taxpayers to opt-in to UK:UK transfer pricing should be considered. It was noted that clarity would be needed on how an exemption would interact with other areas of UK law.

A few respondents suggested the risk to the Exchequer posed by UK:UK transfer pricing arrangements has been reduced by other changes to UK tax law. Examples provided included Corporate Interest Restriction and changes to group relief and associated anti-avoidance provisions for restrictions on carry-forward loss relief (Pt 14B of the Corporation Taxes Act 2010 (CTA 2010)).

Government response

The government recognises that UK:UK transfer pricing places a compliance burden on taxpayers, and that this must be balanced with protection of the UK tax base. The government will relax the obligation to apply transfer pricing between UK entities in situations where the UK tax base is not disadvantaged.

The government will consider whether an exhaustive and specific list of exceptions to an exemption from UK:UK transfer pricing can be practically administrable, without running contrary to its stated aim of legislative simplification.

The government will consider how this relaxation impacts other legislation. The government will permit an opt-in to allow taxpayers to voluntarily apply UK:UK transfer pricing and will consider how to achieve this without presenting opportunities for avoidance.

The government will draft guidance to accompany any legislative change.

Question 5: The government welcomes respondents’ views on Commissioners’ Sanctions. Do they provide assurance and are they valued by taxpayers?

Most respondents agreed that Commissioners’ Sanctions do not provide significant assurance or value beyond HMRC’s existing international risk governance processes. They welcomed the removal of Commissioners’ Sanctions as an appropriate simplification of the current legislation.

Many respondents noted that they consider the existing process for obtaining a Commissioners’ Sanction is unclear to taxpayers. This limits the level of assurance they provide.

Many respondents emphasised the need for consistency in the application of HMRC’s approach in transfer pricing enquiries. They expressed a desire for involvement in the governance process by HMRC’s central transfer pricing policy team.

Many respondents would prefer a system in which taxpayers could, under certain circumstances, request a review by HMRC specialists.

A few respondents felt that the current governance process is not sufficiently robust. They would welcome further clarity and transparency in respect of HMRC’s internal governance processes, with additional guidance available to taxpayers.

One respondent expressed concern that the current governance framework does not exist on a statutory basis. They suggested that the statutory sanction provides additional comfort to taxpayers that appropriate scrutiny has been placed on transfer pricing cases. 

Government response

The government welcomes respondents’ comments. The government notes the common view that Commissioners’ Sanctions provide little to no additional assurance over and above HMRC’s existing governance process. The government agrees with respondents that consistency is needed in HMRC’s approach to transfer pricing enquiries. A robust governance process is an important tool in ensuring this consistency.

The government will remove the legislative obligation for Commissioners’ Sanction. HMRC will consider how existing safeguards and processes can or should be adapted and will look to provide expanded guidance on current governance processes. They will also consider the existing role of HMRC’s central transfer pricing policy team in the review process. 

The government will pursue other avenues to achieve these aims in response to stakeholder feedback, including that received as part of the Review of Tax Administration for Large Businesses.

In November 2021, HMRC announced that it would work with stakeholders to establish a clear and transparent process to accelerate the resolution of long-running transfer pricing enquiries. This involved the development of objective indicators of enquiries in scope. Following detailed engagement a process has been designed and is now in a piloting phase.

Question 6: The government welcomes the views of respondents on the repeal of ss.152 to 154 and 191 to 194 TIOPA and their replacement by a more directly drafted rule. Specifically, what practical issues does the current legislation present, and what benefits should be retained? Are there any alternative options which respondents see which would achieve the aims as stated above?

Most respondents supported the proposals. In particular, many respondents noted that the current legislation can lead to uncertainty and disagreement between HMRC and taxpayers. They welcomed changes that would bring UK domestic legislation more closely in line with the OECD TPG.

A minority of respondents raised concerns with elements of the proposals. These focused on the concept of implicit support, noting that the relevance of implicit support at arm’s length depends on the taxpayer’s individual facts and circumstances. Some proposed that legislative exemptions are considered for certain types of entity for whom its impact is typically negligible.

Many respondents noted that further guidance would be useful in order to provide greater certainty as to how any amended legislation will be interpreted in practice, particularly in relation to the impact of implicit support.

Respondents were split in relation to which option identified in the consultation should be chosen to replace ss.152 to 154 TIOPA. A number of respondents acknowledged that there was more than one reasonable approach and did not express a single preference. 

Some respondents favoured repealing these sections without replacement. It was noted that this would flexibly accommodate different facts and circumstances. For example, it is possible that, in limited circumstances, a guarantee can increase borrowing capacity consistently with the ALP.

Other respondents preferred including replacement provisions in domestic law, mostly favouring a fixed rule disregarding the effect of guarantees on borrowing capacity. A concern was raised that a repeal of ss.152 to 154 TIOPA without replacement may cause uncertainty. One respondent noted the importance of considering how any changes in this area might interact with the proposed relaxation for UK:UK transfer pricing.

Respondents welcomed the proposal to retain the benefits of s.192 TIOPA. A number of respondents emphasised the importance of having clear conditions in order to make a s.192 claim, with some respondents noting that there was some uncertainty under the current legislation. Several respondents noted that the interaction of any amended s.192 with other provisions of the tax code would need to be carefully considered. 

A number of respondents proposed that the current rules should continue to apply to existing arrangements. They noted that reassessing existing arrangements may prove burdensome and that it may not be possible to unwind them without expense.

Government response

The government welcomes the broad support for the proposals and acknowledges the concerns raised.

The government will replace ss.152 to 154 TIOPA with a fixed rule which disregards the effect of guarantees (but not implicit support) on the amount of debt. However, the government intends that this rule would only apply where the provision of the guarantee is within the scope of transfer pricing. This will not always apply in relation to UK:UK guarantees.

The government will retain s.192 TIOPA. The government will also provide a mechanism to ensure that certain UK resident companies that have not provided a formal guarantee continue to be able to make such claims.

The government will consider the impact of a relaxation of UK to UK transfer pricing here. The government will consider transitional rules in relation to existing debt.

The government will issue guidance on the application of any new legislation. Amongst other issues, such guidance would set out the government’s view on the impact of implicit support. This would include its effect for different types of businesses.

The government will not make fixed legislative exceptions from the effect of implicit support for particular types of businesses. It considers that this would be inconsistent with the ALP, interpreted in accordance with the TPG. It notes the difficulty in formulating fixed rules to cover outcomes which are dependent on the facts of individual cases.

Question 7: The government welcomes views on the clarity or otherwise of the resultant impact on the application of other rules. Are there any specific interactions which cause difficulties?

Respondents were split on whether clarification in this area would be useful. Some thought it would, whilst others suggested that the current position is sufficiently clear.

Notwithstanding, some called for clear unambiguous guidance on how the arm’s length fiction is imposed, and how far it extends. An example provided of effective guidance was INTM550085 regarding how the Hybrids Mismatch legislation at Part 6A TIOPA interacts with transfer pricing.

Some considered reference to Part 4 in other legislation helpful in specifying how transfer pricing operates. Others suggested that a more general rule might be a useful simplification and would better enable access to treaty remedies to double taxation.

Government response

The government’s recent experience suggests a need to clarify the interaction between the fiction imposed by transfer pricing (ss.147(3) and (5) TIOPA), and computational rules which determine the ultimate charge to tax. This is reinforced by the fact that some respondents are unclear on that interaction.

The government will consider how best to clarify the current position – either in draft legislation or in guidance. It will not seek to make substantive changes to outcomes other than those specific interactions dealt with below.

Question 8: The government welcomes respondents’ views on the current formulation of the rules at Part 8 CTA 09 which govern the taxation of intangibles transactions between related parties and the proposal to simplify ss.846 and 849 CTA 09.

Question 9: Would a move towards a single valuation standard in cases where transfer pricing otherwise applies reduce compliance burdens?

Question 10: Do respondents foresee any problems having different valuation standards for those subject to transfer pricing and those not subject to transfer pricing (such as many small and medium enterprises); or for different transactions – such as, capital transactions (which are subject to market value rules) and transactions in intangibles?

Question 11: The government also welcomes respondents’ views on whether other UK tax rules which impose an obligation to undertake multiple separate valuation standards are burdensome in practice.

Respondents grouped most of their responses to Questions 8-11 and so these questions have been dealt with together for the purpose of this summary.

Respondents agreed that the current formulation of the rules is potentially burdensome and in parts complex. There was almost unanimous agreement that some form of simplification could reduce compliance burdens.

Most found the broad policy intention behind the current rules straightforward, and some expressed caution that simplification should not undermine that clarity.

Respondents noted that the ability to adjust in both directions to the transfer value of acquired intangibles is in the taxpayer’s favour. This can help to encourage inbound investment.

Respondents noted that, in the majority of cases, there should be no difference between the market value of an asset and its arm’s length price. However, some did consider that there could be material differences in particular cases.

With regards options for simplification, most respondents favoured a unitary arm’s length price standard, citing:

• the use of the arm’s length price in treaties and its adoption and further guidance in the TPG
• the preference of many treaty partners to adopt a single arm’s length price standard
• the potential difficulty in finding market value prices in certain transactions including those where no market comparators exist, and
• the consequential increased effectiveness of the Advance Pricing Agreement (APA) Programme which the arm’s length price provides

A minority of respondents favoured adoption of a single market value rule, on the basis that it might be viewed as a simpler standard to apply in practice in some case. This would equalise the treatment of intangible fixed assets with that of other capital assets.

Some respondents noted there can be added complexity in determining the arm’s length price of some transactions involving intangible assets. In particular, where the functions which contribute to their development, enhancement, maintenance, protection and exploitation are dislocated from their legal ownership.

Some respondents questioned whether transactions involving the exchange of assets for shares, which the ‘higher of’ rule at s.846 CTA 09 was introduced to address, are still relevant. If so, could alternative approaches achieve the same aim?

Many noted that alignment of treatment between transfers and licences of intangible fixed assets would improve consistency and help to simplify the legislation. Some were concerned that the use of different standards for taxpayers within and without the scope of transfer pricing, and for different capital assets, could potentially create problems.

Some respondents asked what would happen in a case where an asset was acquired at market value and subsequently disposed of at arm’s length price, where the difference is solely due to the difference in valuation methodology. They suggested that this would have the potential to lead to “stranded value” where the arm’s length price is lower.

Not all who responded saw these differences as particularly problematic and there was no appetite for moving to the arm’s length pricing standard for all capital transactions.

One respondent suggested allowing taxpayers the ability to elect to choose which standard they wish to use on a case-by-case basis.

Many respondents called for additional guidance in this area, irrespective of the option ultimately pursued. This was as well as transitional rules to reduce the overall burden on taxpayers.

Government response

The government welcomes respondents’ views regarding potential simplification in this area and agrees that any change must comply with the policy objectives behind the regime.

The government agrees with the majority of respondents who preferred the use of a single arm’s length price standard as opposed to a market value rule. The government is considering the full impact of rules which would apply only the arm’s length price standard to transactions within the scope of transfer pricing.

The government considers this outcome preferable, in particular due to its alignment with treaties and the resultant certainty under the APA programme. The latter is of particular benefit given the continued rise in importance of intangibles for MNEs. The UK’s APA programme is an important avenue for tax certainty, which would be of particular benefit in relation to transactions concerning inbound investment into the UK.

The government does not agree that abolishing the arm’s length price standard for intangible transactions is preferable. APAs provide insufficient coverage for such a scenario. In addition, any advantages to certainty/simplicity in the domestic tax computation from a such a move would be lost if such cases ever reached the Mutual Agreement Procedure.

The government agrees that in some cases, dependent on the respective analyses there may not be a material difference between the respective outcomes of the market valuation standard and the ALP.

The government accepts that it will be necessary to consider the options realistically available to both parties in applying the arm’s length price standard. From the seller’s perspective, this will include some assessment of the price which could be achieved in the open market. However, this is not the same as having a legislative override which “tops up” the ALP where the market value is higher. This, as noted above, has an impact on the availability and coverage of APAs.

The government acknowledges the potential complexity in cases which might be caused by a different valuation standard for those taxpayers not within the scope of Part 4. However, we note that this complexity is already present given the dual standard only applies in relation to those taxpayers and assets subject to both transfer pricing and the intangible fixed regime.

A small, or medium enterprise is permitted to opt out of the transfer pricing exemption. Beyond this the government is not persuaded to permit taxpayers to voluntarily elect for a particular valuation standard because of Exchequer risk.

The government agrees that alignment between treatment for transfers of, and grants of licences in relation to, intangible assets would be beneficial. However, the government is still considering whether or not to allow the ability to adjust valuations in both directions. This would be contrary to the ‘‘one-way street’’ inherent in transfer pricing.

The ‘one-way street’ ensures there is no double non-taxation caused by asymmetry in treatment on either side of a transaction. This is equally possible in transactions in intangible assets as it is in any other related party transaction.

The government does not accept that the location of activity relating to intangible assets should, in and of itself, alter the value of an asset. However, HMRC will aim to produce additional guidance in this area to supplement the guidance in the OECD TPG.

The government will review options to address special situations, such as where an asset is exchanged for non-monetary consideration. It will consider whether these can be dealt with in a targeted manner.

Question 12: The government welcomes views from respondents on whether there are any concerns in relation to the rules which govern the interaction of transfer pricing and the Loan Relationship and Derivative Contract regime rules at parts 5 and 7 CTA 09 – whether they are understood, whether they adequately achieve their desired function, and whether any practical difficulties in application exist.

Many respondents agreed that these rules are complex and welcomed their simplification. Some respondents noted that the rules were generally understood but most of these respondents nevertheless identified particular areas for reform. It was also suggested that, given the complexity of these provisions, it is of particular importance that stakeholders  are consulted on draft legislation.

Some respondents supported an alignment of the ‘independent terms assumption’ at s.444 CTA 09 with the ‘arm’s length principle’, interpreted in accordance with the OECD TPG. A few respondents considered that s.444 CTA 09 was unnecessary in the light of the transfer pricing rules. Some respondents considered that the current rules may give rise to inconsistencies or tax asymmetries.

In relation to s.446 CTA 09 and s.693 CTA 09, some respondents raised concerns about consequences of the period-by-period application of the ‘‘one-way street’’ rule. Respondents considered that this may result in mismatches in treatment of a single instrument over multiple periods, such as in relation to fair value movements. Some respondents suggested that provisions be introduced to mitigate such mismatches.

One respondent considered that a single approach of using market value should be adopted for all taxpayers irrespective of whether the transfer pricing provisions could apply or not.

A few respondents suggested that detailed guidance is provided as part of any reforms.

Government response

The government will simplify and clarify these rules. The government does not currently intend to repeal s.444 CTA 09.

The government recognises the complexity inherent in this area, and the need to consult on any changes before they are ultimately legislated.

Question 13: The government welcomes views on the tax treatment of adjustments to foreign exchange movements gains and losses which arise following the application of Part 4.

Many respondents agreed that the current rules in relation to the adjustment of exchange gains and losses following the application of Part 4 are complex and welcomed simplification. Though a number noted that the current rules broadly achieved their aim and are well understood.

Some suggested the current rules could lead to inconsistent applications of the ALP. However, respondents were divided on how to address any such concerns. Some favoured allowing transfer pricing to directly adjust exchange gains and losses and others opposed such a change.

Many respondents considered it important for the rules to continue to consider where a loan or derivative is matched. This avoids transfer pricing inadvertently creating an unmatched position. However, a few respondents noted that they would welcome clarification in respect of the current wording of the legislation regarding matching.

A few respondents raised concerns about consequences of the ‘‘one-way street’’ rule. One respondent suggested that the reversal of adjustments to exchange gains and losses made as a result of the operation of the transfer pricing legislation should receive relief in future periods. This should apply even if the “’one-way street’” is retained in relation to other components of any transfer pricing adjustment.

One respondent raised concerns with the application of the current legislation to interest free loans as s.447 CTA 09 would not apply to such debtor relationships due to the ‘one-way street’.

One respondent raised concerns that the application of s.452(2) CTA 2009 is not clear where several connected companies could all make a s.192(1) TIOPA claim and where an actual s.192(1) TIOPA claim has been made.

Government response

The government will simplify these rules with the aim of bringing exchange gains and losses within the direct ambit of Part 4 TIOPA.

The government will retain rules relating to matching of exchange gains and losses.

The government recognises the complexity inherent in this area, and the need to consult on any changes before they are ultimately legislated.

Permanent Establishment

General comments

Respondents 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.

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 main observations on this aspect centred on details which need to be considered when drafting legislation.

However, on the subject of PE definition, many respondents expressed concern that the proposals would introduce additional complexity and uncertainty. This would result in further compliance burden for taxpayers in contrast to the stated aims of the reform. This reflects the cautious response which the OECD changes received from businesses back in 2017.

The majority of respondents’ concern centres on the 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’.

The concern is that these changes will:

• 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 our 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.

Question 14: The government welcomes general observations from respondents regarding the perceived advantages and disadvantages of each option for amending the PE definition.

Responses that stated a preference between the two options were split with no consensus on the best approach. However, the majority favoured option a), to define a UK PE and attribute profits by reference to the relevant double taxation treaty. Where no treaty is in place, the 2017 OECD MTC would be used.

This contrasted with option b) which defined a UK PE by reference to the 2017 OECD MTC, which would then be subject to the relevant treaty, as is the case now.

Some respondents noted that in the short to medium term there would be limited difference in the outcome between the approaches. This assumed that the UK does not adopt Article 12 of the BEPS Multilateral Instrument (MLI) or amend existing treaties to include the revised wording in Article 5 of the 2017 OECD MTC.

Under either option a) or b) most respondents highlighted that adoption of the 2017 OECD MTC definition of a dependent agent PE (‘DAPE’), and the more restrictive agent of independent status exemption, effectively lowers the threshold for a PE. Subject to treaties, this could result in the creation of additional PEs increasing compliance burden for MNEs.

Some respondents felt that adopting the OECD definitions would place the UK out of line with other territories which did not adopt all of the changes to Article 5 at an international level. This includes several G7 countries. In their view, the current OECD definition may not in practice represent an international consensus and so aligning domestic law with it may not be appropriate.

Several respondents favoured retaining the current UK domestic legislation definitions noting that these are well understood. In their view, the proposed changes introduce uncertainty. Especially as they consider some aspects of the revised definitions in the 2017 OECD MTC to be difficult to apply in practice.

Regardless of the approach, several respondents requested confirmation that the government will not change the requirement to be ‘trading’ in the UK when considering if there is a UK PE. There was widespread support for the proposal to keep the basic charging provision for non-resident companies in s.5 CTA 09 unchanged.

Those respondents that favoured option a) believed that aligning UK domestic legislation with the treaty would provide clarity and consistency to taxpayers. As it would eliminate differences between the domestic and treaty positions. This would allow taxpayers to refer directly to the treaty and remove the ‘two-tiered’ system of first considering the domestic position then the treaty.

Some respondents had concerns about referring directly to the definitions in Article 5 of the 2017 OECD MTC under option b) rather than setting out the definitions in domestic legislation. They felt that this would result in the UK losing control over its domestic tax policy. Under this approach any future changes to OECD definitions would automatically be incorporated into UK legislation even if the UK did not support the changes.

One respondent highlighted that option a), which takes the treaty first, could create new friction with the fundamental charging provision in s.5 CTA 09.

Respondents who preferred option b) believed that it would provide a consistent approach irrespective of the counterparty jurisdiction. It would allow taxpayers to refer directly to the 2017 OECD MTC commentary to assess whether they have a PE.

Those that favoured option b) felt the approach would ensure that the UK domestic position remained in line with the OECD going forward.

Government response

The government will ensure that it maintains control over UK tax policy including the determination and scope of its taxing rights over non-UK companies.

In recognition of points raised the government will continue to consider whether to adopt the definition of a PE contained in Article 5 of the 2017 OECD MTC in UK domestic legislation.

If the definition is adopted, then the government would follow option b) and retain a static definition in UK legislation that includes relevant exemptions. This approach would ensure continuity and prevents any friction with the fundamental charging provision in s.5 CTA 09, which will be unchanged.

As is the case now, the application of domestic law will remain subject to the terms of any double taxation treaty. This reflects the fact that taxation of non-resident companies has always been an area where countries cooperate and act with a reasonable level of consistency because this is to all countries’ mutual benefit.

The government will consult again on any draft legislation in this area, allowing stakeholders another opportunity to highlight any concerns over the accuracy or suitability of any updated statutory definitions and exemptions. 

Question 15: Do respondents foresee any issues with the UK limiting this definition to fixed place of business and dependent agent PEs?

Respondents did not foresee any issues with limiting the definition of a PE to a fixed place of business and a DAPE.

Government response

The government will retain a static PE definition limited to fixed places of business and dependent agents.

Question 16: Do respondents foresee any specific issues with the UK changing its domestic law position in terms of the definition of a dependent agent PE? Do respondents foresee any specific issues with the UK changing its domestic law position in terms of the definition of an independent agent?

Broadly respondents believed that expanding the definition of a dependent agent PE to align with Article 5(5) of the OECD MTC would give rise to additional PEs across various sectors. This includes insurance, financial services and, in particular, asset management.

A few respondents across various sectors suggested alignment risks the creation of small or ‘nil’ PEs. This would result in additional filing and compliance costs for both businesses and tax authorities where there is either nil or minimal tax at stake.

Several respondents raised concerns that the wider definition of a DAPE would not lead to greater clarity and could instead increase uncertainty resulting in greater compliance burdens.

Respondents highlighted the need for the government to provide guidance on the UK interpretation of specific terms contained within Article 5(5) of the 2017 OECD MTC. This would be new to UK legislation.

All respondents who discussed the asset management sector stated that the changes could have significant impacts for the sector – this is discussed in detail under Question 22.

Most respondents acknowledged that a change in the UK domestic law position would have limited impact in the short to medium term where a treaty is in place.

Those provisions reflect the 2017 OECD MTC Articles 5(5) and (6) and concern the artificial avoidance of PE status through commissionaire arrangements and similar strategies. Respondents urged the government to clarify its position with regards to withdrawal of the UK’s reservations against Article 12 MLI to provide certainty to taxpayers.

It was noted, however, that in cases where there is no double taxation agreement, the changes could have an immediate impact.

Government response

The government notes the concerns expressed by stakeholders in this area and continues to reflect on the potential impact of adopting the definition of a PE contained at Article 5 of the 2017 OECD MTC in UK domestic legislation. The government will hold a technical consultation on any proposed changes to domestic law.

Discussions are ongoing with stakeholders in the asset management sector to ensure that any changes do not have unintended consequences for foreign investors in funds which are managed or advised upon in the UK.

Question 17: Do respondents foresee any issue with the UK potentially changing its negotiating position, so that UK tax treaties might include these provisions?

Some respondents did not foresee any issue with the UK changing its negotiating position.

However, several respondents believed the change might restrict the UK’s negotiating position. They expressed concern that, as treaties cover multiple aspects of double taxation in addition to PEs, limiting the UK’s position with regards to Article 5(5) & (6) could reduce flexibility and remove the ability to negotiate on these to reach agreement on other potentially valuable areas.

A few respondents cautioned against the UK taking a default approach in treaty negotiations. Instead, they suggested that the decision to include the revised definitions should be made on a case-by-case basis. They highlighted that other jurisdictions may take a wider view on PEs. So adopting the OECD definitions in both domestic legislation and treaties would result in UK taxpayers spending time and incurring costs defending their position.

Government response

The consultation focused on UK domestic legislation and there will be no change to the UK’s reservations in relation to Article 12 of the BEPS MLI as a result of this reform.

The government acknowledges respondents’ concerns in relation to any change in the UK’s tax treaty negotiating preferences on PE. UK tax treaty policy will continue to evolve and adapt to prevailing economic and policy concerns. Given our position as a leading OECD member country, the government will further consider its approach in relation to future treaties but notes that existing treaties would be unaffected by any future change of negotiating position.

Question 18: Do respondents foresee any issues with the UK aligning the domestic legislation on PE attribution either directly with the relevant double taxation treaty or with Article 7 of the OECD Model supported by the Commentary and the OECD Report on the Attribution of Profits to PEs?

Respondents generally supported aligning domestic legislation on PE attribution with either the relevant taxation treaty or Article 7 of the OECD MTC.

Those which favoured aligning with the relevant treaty believed that it would provide consistency between domestic legislation and the treaty position.

One respondent cautioned against simply aligning with Article 7 of the OECD MTC highlighting that the UK would lose control of the domestic tax impact, as a result of future amendments to Article 7 and/or the commentaries.

Others noted that HMRC guidance already makes clear the UK’s intention to fully align with the OECD position. Therefore, formally setting out the position in relation to Article 7 does not present any issues.

One respondent believed that it would be preferable to align the UK’s domestic legislation with Article 7 of the 2017 OECD MTC, rather than referring to the relevant double taxation treaty, as this will ensure that the UK has a consistent approach to profit attribution regardless of the relevant counterparty jurisdiction. It will provide certainty to taxpayers by ensuring that the maximum amount of profits that could be attributed to a UK PE aligns with the 2017 OECD MTC.

Several respondents highlighted that a number of existing treaties pre-date the AOA with some treaty partners not adopting the AOA. Accordingly, the pre-AOA commentary on Article 7 will remain relevant in relation to these jurisdictions. Respondents, therefore, requested clarity on the use of later commentaries and the AOA in the interpretation of such treaties.

Another respondent suggested that the wording of the Business Profits Article in a treaty should be interpreted for domestic purposes in accordance with the commentary in existence at the time the Business Profits Article came into force.

Government response

Noting the broad support for a refresh of the profit attribution legislation, the government will hold a technical consultation on draft domestic legislation. This will align with the current version of Article 7 of the 2017 OECD MTC.

The government recognises that there is a need for better guidance on how to apply the OECD commentary and the AOA to domestic attribution cases. This is something that will be explored as part of the technical consultation.

Question 19: Would removing any particular aspects of the legislation in Chapter 4 CTA 09 be problematic?

Whilst respondents supported aligning UK domestic legislation with Article 7 and welcomed repealing redundant legislation, some believed that parts of Chapter 4 CTA 09 provided additional clarity to MNEs and those sections should therefore be retained.

However, although preferable to retain such provisions, respondents suggested that where they are removed, appropriate guidance should be provided. This will cover the application of the ALP to scenarios covered by such sections.

A few respondents requested clarity on the interaction between profits attributed to a PE under the new proposals and the application of the wider tax rules. They added that the UK government should be mindful of the impact of any changes on other regimes and to ensure that they continue to operate effectively.

Government response

The government recognises that the current statute on attribution is challenging to reconcile with the equivalent treaty position. Bringing the domestic attribution rules into line with the latest OECD position, will ensure that it is clear that the current commentary and the AOA can be used in all cases.

Respondents seem to agree that increased certainty over the domestic starting point is necessary. The government will ensure that guidance is drafted to try to mitigate, as far as practicable, uncertainty over the interpretation of certain aspects of the attribution process. These are currently covered individually in statute.

Question 20: The government welcomes respondents’ views about possible unforeseen and/or unhelpful consequences or interactions with other parts of UK tax legislation which are not addressed in the above proposals.

Some respondents recommended simplifying the filing requirements for PEs to permit filing a single return covering the DAPE of a UK Dependent Agent Enterprise (DAE) and the DAE. Currently, the DAE and DAPE each have to file a separate return. One respondent cited the Netherland’s approach as an example.

A few respondents highlighted that a simplified filing requirement together with clear guidance would provide certainty to taxpayers and minimise compliance burdens. Especially considering the potential for the creation of additional small or ‘nil’ PEs following the adoption of the 2017 OECD MTC definitions of a DAPE and agent of independent status.

Government response

The PE legislation is relatively self-contained and respondents did not identify any previously unforeseen consequences from the proposed changes.

The issue of negligible and nil PEs is a longer-term issue which is linked to subsequent developments in the treaty position. Several respondents highlighted the impact of globally mobile and hybrid working on PE issues and the fact that the OECD will be looking to address this in coming years. The issue of administrative easements for negligible and nil value PEs is something the government will consider alongside these multilateral discussions.

There was some support for the alignment of the OECD basis for the branch exemption for foreign PEs with the domestic rules for UK PEs. Foreign branch exemption was also highlighted as an area where problems may arise if the basic trading provision was disturbed under option a (see question 14).

Question 21: The government also welcomes any specific additions, exceptions or exemptions which respondents deem helpful to identify or add in at this stage.

Respondents welcomed the government’s intention to retain existing exemptions. This includes the IME and the IBE. This is discussed below under Q22.

Several respondents recommended expanding the scope of the reform to include the Income Tax rules on trading profits arising in the UK. This would give greater certainty about the scope of income tax for non-resident individuals and companies.

Some respondents noted the upcoming discussions at the OECD centred around globally mobile workers, particularly the potential for employees working from home to create a PE of a non-resident company.

A few respondents believed that the reform should follow the conclusion of those discussions, to take into account OECD recommendations and guidance. Others suggested that the UK take a lead on the matter and introduce legislation with supporting guidance on the issues as soon as practically possible.

Government response

The government acknowledges the potential mismatch with income tax. In rare cases, foreign companies can become liable to income tax, rather than CT, on profits of a UK trade. There is no equivalent PE restriction under income tax.

Whilst it might be preferable to remove this inconsistency, in discussions with business stakeholders, no examples were cited of businesses actively being taxed in this way. As this forms part of the basic Income Tax charging provision, it is not within the scope of this consultation to address this. 

Question 22: The government welcomes comments from respondents on the potential impact of the reforms contemplated in this consultation on the UK asset management sector.

Respondents that answered this indicated that the adoption of the Article 5(5) & (6) of the 2017 OECD MTC would have a significant impact on the asset management sector. It would introduce uncertainty and reduce the UK’s competitiveness. Respondents indicated that this could lead to some investment activities currently carried on in the UK moving offshore.

Respondents explained that UK investment managers often have the ability and authority to negotiate contracts and make contractual changes in respect of the non-UK funds they manage. This potentially creates a DAPE of the funds they manage. Fund managers commonly rely on either the independent agent exemption within an applicable treaty or the IME to prevent the creation of a PE under domestic legislation.

Most respondents welcomed the government’s intention to retain the IME but highlighted that there are cases where the conditions of the IME are not satisfied. As a result fund managers instead place reliance on the agent of independent status exemption within an applicable double taxation treaty.

In addition, monitoring the IME is complex with a compliance burden. So there are circumstances where investment managers apply the agent of independent status exemption within an applicable double taxation treaty rather than seek to satisfy the IME.

Respondents had concerns that adopting Article 5(6) and 5(8) may create DAPEs of offshore investment funds where the IME is not satisfied.

This is because Article 5(6) will prevent an agent who “acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related” from being categorised as independent. It is possible that some investment managers will be considered “closely related” to the funds they manage by virtue of Article 5(8) and therefore unable to rely on the Article 5(5) exemption.

Those funds that potentially satisfy the IME but instead rely on Article 5(5) due to the complexity of applying it will incur additional compliance costs and spend significant time establishing whether the IME is satisfied.

One respondent suggested that it may be necessary to introduce an additional separate UK definition or interpretation of the term ‘closely related’. This is applicable in the context of investment funds, to prevent such unintended PEs from arising.

Respondents also highlighted that the inclusion of agents which “habitually play the principal role leading to the conclusion of contracts that are routinely concluded without modification by the enterprise…” could capture, as a PE, UK investment advisers or sub-advisers who advise offshore investment managers from the UK but don’t conclude contracts.

Several respondents pointed out the changes would place a greater reliance on the IME. They urged the government to retain its original intentions and not limit the scope of the exemption. Some respondents suggested that the government simplify and widen the scope of the IME as part of the reform.

Government response

The government acknowledges the concerns raised by the UK asset management sector. It will consult further with respondents to ensure that the reforms are not implemented in a way which has an adverse impact on the sector. In particular, a sub-adviser treated as an agent for the purpose of the PE rules will also be treated as such by the IME.

Question 23: Do respondents foresee any issues with the removal of specific independence criteria for Lloyd’s agents (currently at s.1151 CTA 10)?

Respondents did not foresee any issues with the proposed removal of the specific independence criteria for Lloyd’s agents.

Government response

As there were no adverse responses to this specific aspect of the reform proposals, the government will repeal this part of the legislation as part of the wider reforms.

Diverted Profits Tax

General comments

The majority of respondents welcomed the proposal to remove DPT’s status as a separate tax and bring the diverted profits regime into the CT framework. In particular, respondents agreed that closer alignment with the CT enquiry framework could simplify the UK tax system and improve certainty. Respondents were also in favour of access to double taxation relief under the UK’s treaty network.

The majority of respondents were in favour of repealing and not directly replacing s.86 of the Finance Act 2015 (FA 2015) of the DPT legislation. S.86 FA 2015 targets arrangements designed to avoid a UK PE.

Respondents requested clarification on how the administration of the diverted profits regime would be incorporated within the CT framework and on the interaction with MAP and the Pillar 2 measure.

Most respondents suggested that the government should evaluate whether a diverted profits regime is still required. These respondents referenced the improvements in the OECD TPG. This follows the OECD’s Base Erosion and Profit Shifting work and the ongoing work on the 2 Pillar Solution.

Many respondents expressed an interest in reviewing the draft legislation at a technical consultation in the future. Some respondents were interested in further guidance on the Effective Tax Mismatch Outcome condition (ETMO) and Insufficient Economic Substance Condition (IESC).

Question 24: The government welcomes respondents’ views as to whether this closer alignment of a diverted profits charge assessment to the CT enquiry framework would be a welcome simplification.

Most respondents agreed with the proposal to remove the separate DPT and more closely align a new diverted profits assessment with the CT enquiry framework. It was welcomed as a simplification, improving certainty for businesses in respect of access to the UK’s treaty network.

Most respondents suggested that the government should evaluate whether a diverted profits regime is still required. The respondents referenced the improvements in the OECD TPG following the OECD’s Base Erosion and Profit Shifting work and the ongoing work on the 2 Pillar Solution.

Several respondents suggested that the government should evaluate other legislative areas, such as the penalty regime, information powers, and Offshore Receipts in respect of Intangible Property (‘ORIP’) regime.

Other respondents wanted clarification on how the diverted profits regime would be administered within the CT enquiry framework. There was specific mention of the following:

• raising notices (with or without enquiries)
• tax rate
• payment and relief mechanisms
• interaction with the Senior Accounting Officer requirements
• interaction with the transfer pricing documentation rules

Respondents were also interested in how the assessment would interact with MAP.

Respondents queried whether the duty to notify regime remain if DPT was not a separate tax.

It was suggested that the government should consider extending the notification deadline to match the CT return deadline of 12 months after the end of the accounting period.

Another suggestion was to alter the deadline for issuing a Supplementary Charging Notice, so that it was not the same as the last date for a customer to amend their CT Self-Assessment return to bring taxable diverted profits into charge to CT. This is because it would be helpful for businesses to have clarity on HMRC’s final position prior to the customer’s amendment deadline.

Government response

The government appreciates the predominantly positive reaction to the proposal for greater alignment of the diverted profit regime and the CT enquiry framework.

Tax simplification remains an important objective. The government believes that removing the separate DPT and bringing the diverted profits regime within the CT framework represents significant simplification. The government also recognises the comments requesting an evaluation of the continued need for a diverted profits regime.

DPT remains a useful tool for HMRC in encouraging MNEs to pay tax on their economic activities in the UK. The government will continue to keep the regime under review and will consider the impact of the evolving tax landscape. 

In respect of the work on the 2 Pillar Solution, there are some important differences between Pillar 2 and other measures that protect the UK tax base. However, the Pillar 2 global minimum tax will have a significant impact on the international CT landscape. It will be appropriate, once the Pillar 2 rules are in place, to review its impact on CT.

This review may identify opportunities for reforms that could further simplify UK tax rules and reduce compliance burdens, without exposing the UK tax base to significant risk.

The government will set out further information on the administration of the reformed diverted profits assessment at a technical consultation.

The government expects that MAP will be available where a diverted profits assessment results in double taxation. The detail of how a diverted profits assessment will interact with MAP will be set out at a technical consultation.

Question 25: The government invites respondents’ views on bringing Diverted Profits Tax into the CT framework as a standalone CT charge at a higher rate in respect of arrangements designed to inflate expenses, reduce income, or avoid a UK PE.

The majority of respondents welcomed the proposal to bring DPT into the CT framework. Respondents noted it would reduce administrative burdens for taxpayers. It would also provide certainty on access to the UK’s treaty network and MAP to resolve potential double taxation.

A few suggested that the introduction of a standalone CT charge for diverted profits could hinder HMRC’s ability to tackle arrangements designed to inflate expenses, reduce income, or avoid a UK PE. 

Government response

The government appreciates the helpful responses that set out the benefits to taxpayers from the removal of DPT’s separate tax status.

The government’s view is the DPT regime would operate efficiently within the CT framework as a standalone CT charge. That will successfully tackle arrangements designed to inflate expenses, reduce income or avoid a PE.

Question 26: The government welcomes respondents’ views as to whether it would simplify the legislation not to directly replace s.86 FA 2015 and instead use a diverted profits assessments on UK entities to challenge arrangements which would currently fall under s.86 FA 2015 and any other comments in respect of s.86 FA 2015 and avoided PEs.

Most respondents agreed with the proposal to not directly replace s.86 FA 2015 and instead use diverted profits assessments on UK entities to challenge those arrangements. Respondents noted it would be a welcome simplification for businesses that could decrease complexity and prevent duplication.

Some respondents flagged the continuing need for HMRC to be able to challenge these types of arrangements if s.86 FA 2015 is repealed and not directly replaced.

A few respondents commented that any changes to s.86 FA 2015 would need to consider the PE consultation developments.

Other respondents commented that it would be useful to review draft legislation to understand the policy proposal further. It was suggested that the s.86 FA 2015 rules could sit as anti-avoidance PE legislation.

Government response

The government welcomes the positive comments from respondents. The government believes it can tackle these arrangements successfully under the new diverted profits assessment. The government will ensure any proposed changes to the PE legislation are considered alongside the changes to DPT.

The government will set out further information with draft legislation at a technical consultation.

Question 27: The government welcomes the views of respondents as to whether amending the definition of reduction in income in s.107(3) FA 2015 and changing the definition of ‘qualifying loss relief’ would bring clarity and would welcome any other comments in respect of the functioning of the ETMO.

Most respondents agreed amendments to the reduction of income definition at s.107(3) FA 2015 would provide clarity on the functioning of the ETMO test. Respondents noted there was uncertainty regarding the interpretation of the definition notwithstanding HMRC’s position has been set out to taxpayers in guidance.

Several respondents requested clarification on how any ETMO test would interact with the OECD Pillar 2 rules.

It was suggested that the ETMO test should be altered to prevent two-way flow transactions being captured incorrectly, such as reinsurance transactions.

A few respondents suggested that the ETMO test should align with the Pillar 2 rate of 15%, and the 80% payment test should be reduced to 60% accordingly.

Government response

The OECD Pillar 2 rules are an overlay to, rather than a replacement for, domestic provisions such as DPT. The UK’s multinational top-up tax will be laid on top of relevant domestic provisions including DPT.   

The government understands the views regarding reinsurance transactions and has taken this into account within the policy proposal. The government will set out further information on the draft legislation at a technical consultation.

The government’s view is that setting the ETMO test at 80% of the CT that would have been payable on the diverted profits is the appropriate rate for the diverted profits regime.

Question 28: The government welcomes respondents’ views as to whether amending the provisions for the calculation of the taxable diverted profits would bring clarity on the application of the legislation to loss-making companies.

Many respondents agreed with the intention to amend the taxable diverted profits calculation provision to clarify the position on loss-making companies. Respondents noted it would be a reasonable approach and avoid ambiguity.

Other respondents requested clarification on whether loss-making companies would be required to pay cash charges on diverted profit assessments, particularly if the activities are generating losses in the current year. Respondents wanted more information on how losses could be ringfenced from being offset against diverted profits.

Government response

The government acknowledges the requests for clarification. It believes that there could be difficulties retaining the application of a cash charge for loss-making companies under the reformed diverted profits regime. Particularly where the activities in question are generating losses. The government will provide further information with draft legislation at a technical consultation.

The government believes it is essential that the application of the diverted profits regime does not generate an advantageous position for taxpayers that have diverted UK profits. The government believes the ringfencing of losses would achieve this aim.

Question 29: The government welcomes respondents’ views on options to clarify the scope of the IESC and amending the legislative definition of the tax reduction, to improve the functioning of the IESC.

Some respondents agreed that clarification on the scope of the IESC and the legislative definition of the tax reduction would be welcome.

Respondents noted that the current legislative drafting of the scope of the IESC could be perceived as subjective and broad. Others requested more information on the policy proposals around the scope of the IESC including the avoided PE limb.

It was suggested that the IESC could be renamed to avoid confusion.

A few respondents noted that the current legislative definition of the tax reduction is clear.

Most respondents would welcome further legislative definition, or additional guidance regarding the application of the safe harbour provisions. These are currently outlined in s.110(7) FA 2015. It was noted the safe harbour provisions can be difficult to apply in practice.

Many respondents highlighted a purpose test would be preferrable to the current legislative drafting of “reasonable to assume…designed to secure the tax reduction”. Respondents stated purpose tests are more objective and supported by case law in comparison to the current legislative test.

Some respondents noted there could be merit combining the entity test at s.110(6) FA 2015 and transactions tests at s.110(4)-(5) FA 2015 to make the application of the IESC clearer. Respondents highlighted it is difficult to apply the IESC where only one test is met.

Government response

The government acknowledges the responses proposing that a purpose test may offer further clarity. However, it is the government’s view that the IESC test functions efficiently as a reasonable to assume test.

The government has reviewed the safe harbour conditions and believes clarifying the scope of the IESC in legislation will reduce the reliance on the safe harbours.

The government will provide further information with draft legislation at a technical consultation, which will explain how the IESC will operate in the new regime.

Question 30: The government welcomes respondents’ other comments how to modify the IESC to improve its functioning, and the areas that cause the most complexity.

Many respondents commented that the safe harbour provisions at s.110(7) FA 2015 are difficult to apply in practice. It was suggested s.110(7) FA 2015 could be replaced with a test linking to the overall transfer pricing analysis and that it could be clearer that activity relating to intangible assets would be considered in calculating non-financial benefits.

Some respondents suggested further guidance on the application of the safe harbour provisions and the calculation of the non-financial benefits would be useful.

Some respondents noted there could be merit combining the entity test at s.110(6) FA 2015 and transactions tests at s.110(4)-(5) FA 2015. This would make the application of the IESC clearer. Respondents highlighted it is difficult to apply the IESC where only one test is met.

Government response

The government welcomes respondents’ comments around modifications to the IESC.

The government will consider further guidance around the safe harbour conditions and is open to further feedback.

The government will provide further information with draft legislation at a technical consultation. This will explain how the IESC will operate such as the entity and transaction tests.

Question 31: The government welcomes respondents’ views on this change to the circumstances in which an amending notice can be issued and the scenarios where they consider such a policy should apply.

Most respondents welcomed the proposal to alter the circumstances in which an amending notice can be issued. Respondents noted the proposal would ensure that charging notice payments are not required in circumstances which would be inappropriate, such as where there are known mistakes or errors.

Some respondents highlighted circular payment situations as another scenario this policy could apply to.

Government response

The government appreciates the responses welcoming this proposal and will set out draft legislation at a technical consultation on the changes.

Question 32: The government welcomes respondents’ views on amending the definition of the material provision to ensure that it identifies the arrangements actually entered into by the relevant parties and any other comments in respect of the material provision.

Most respondents agreed with amending the definition of the material provision to ensure it identifies the arrangement actually entered into by the relevant parties. A few respondents stated the current legislative definition of the material provision was clear.

Many respondents suggested any amendment to the definition of the material provision should consider the outcome of the transfer pricing consultation. It was suggested that material provision should be altered to arrangements or actual provision.

Respondents welcomed the opportunity to provide further comments once draft legislation is published.

Government response

The government agrees with the respondents and any changes to the transfer pricing legislation will be considered in respect of the diverted profits regime.

Question 33: The government welcomes respondents’ views on amending the definition of the Relevant Alterative Provision to the arm’s length provision and would welcome any other comments in respect of the Relevant Alterative Provision.

Many respondents agreed with amending the definition of the Relevant Alternative Provision (RAP) to the arm’s length provision to align with the ALP. Some respondents queried whether incorporating the RAP, as it stands, within the policy would extend the scope further than internationally accepted standards and OECD TPG.

Other respondents requested further clarification on the policy proposals for the RAP.

Government response

The government agrees that amending the definition of the RAP to the arm’s length provision would increase certainty and clarity by incorporating the internationally accepted standard. The government considered OECD principles when designing the proposals.

The government will set out the draft legislation at technical consultation.

Question 34: The government welcomes respondents’ views on whether the legislation currently at s.85 FA 2015 would be sufficient to enable calculation of diverted profits charges in all cases if the Relevant Alternative Provision is updated as described.

Some respondents agreed the legislation at s.85 FA 2015 would be sufficient to enable calculation of diverted profits charges in most cases, provided the definition of the RAP is updated to incorporate the arm’s length provision.

Other respondents requested further clarification on the policy proposals for the RAP.

Government response

The government agrees the legislation at s.85 FA 2015 would be sufficient to enable calculation of diverted profits charges in all cases if the RAP definition is updated.

The government will set out the draft legislation at technical consultation.

Question 35: The government welcomes respondents’ views on whether (if the actual provision condition is retained) updating the inflated expense condition would improve the operation of the diverted profits regime and would welcome any other comments in respect of the inflated expense condition.

Many respondents agreed that the Inflated Expense Condition should be updated to prevent excessive charges where better information is available.

Other respondents suggested it would be appropriate to remove the inflated expense condition. Any assessments to tax should be based on HMRC’s best estimate of the correct amount of tax due based on the information available at the time.

Government response

The government agrees the Inflated Expense Condition should be removed to enable HMRC to use the best evidence available to quantify the amount to disallow where it has reason to believe that expenses are inflated.

Next steps

Since the consultation closed on 14 August 2023, HMRC has been considering the evidence submitted in response to the consultation and exploring ideas to inform the further design of the policy.

The government has listened carefully to the views expressed in the consultation and where appropriate has taken these views into account in continuing work to develop these reform proposals.

In particular, the government notes that many respondents wanted the opportunity to review and comment on draft legislation. As a result, the government will hold a technical consultation on draft legislation in 2024.

Annexe A: list of stakeholders consulted

ABI	AIMA	Anglo American
Association of British Insurers	Aviva	Azets
BDO	Benefact Group	Bentley
Blick Rothenberg	BVCA	CIOT
City of London Law Society	Deloitte	EY
FTI Consulting	Gareth Green	Grant Thornton
ICAEW	International Valuation Standards Council	Investment and Life Assurance Group
Johnston Carmichael	KPMG	Legal and General
Linklater	Lloyd’s of London	Macfarlanes
Managed Funds Association	Mazars	Public Sector Pension Investment Board
PWC	RSM	Sidley Austin LLP
Silicon Valley Tax Directors Group	Simmons & Simmons	Skadden
Slaughter and May	The Law Society	Travers Smith
UK Finance Limited	Veolia	Vodafone
Watson Farley & Williams