Policy paper

Reform of UK law relating to transfer pricing, permanent establishment and Diverted Profits Tax

Published 28 April 2025

Who is likely to be affected

All UK businesses within scope of the transfer pricing or permanent establishment legislation, and potentially within scope of the Diverted Profits Tax legislation, advisory firms, representative bodies, and legal firms.

General description of the measure

The government will introduce a package of draft legislation in respect of the UK’s rules on transfer pricing, permanent establishment, and Diverted Profits Tax.

Transfer pricing is a means of pricing transactions between connected parties, based on the internationally recognised arm’s length principle. That principle seeks to determine what the price would have been if the transactions had been carried out under comparable conditions by independent parties.

This measure has been designed to simplify the UK transfer pricing rules in a number of areas including the participation condition, intangibles, commissioners’ sanctions, UK-to-UK transfer pricing, and financial transactions. 

Permanent establishment is a concept in international taxation. Double taxation treaties between territories set rules to determine which state has the priority in taxing rights in certain circumstances to avoid double taxation. A state is permitted to tax a non-resident company’s profits to the extent that they are attributable to a business carried on in that state through a permanent establishment.

This measure is designed to bring the UK’s permanent establishment rules into line with the latest international consensus on both the definition of a permanent establishment and the attribution of profits to a permanent establishment. It will also clarify which supporting guidance and materials can be used in conjunction with UK legislation and update the legislation and Statement of Practice on the Investment Manager Exemption.

Diverted Profits Tax was introduced in 2015. It 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 permanent establishment rules.

The proposed legislation creates a new charging provision for Unassessed Transfer Pricing Profits within Corporation Tax. This is a significant simplification, repealing Diverted Profits Tax in its entirety while retaining the essential features of the regime.

Policy objective

This measure is designed to simplify the UK’s international tax rules, bring them up to date, and align them more closely with the UK’s obligations under double taxation treaties.

The package of reforms is intended to:

• improve fairness — ensuring multinational enterprises pay tax on profits generated 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

Background to the measure

The previous government consulted on proposals to reform the UK’s legislation on transfer pricing, permanent establishment and Diverted Profits Tax in the summer of 2023 and issued a summary of responses in January 2024.

In the Corporate Tax Roadmap 2024, the current government committed to holding a second round of consultation on this measure in spring 2025.

Detailed proposal

Operative date

The earliest operative date for this measure will be from 1 January 2026.

Current law

The UK transfer pricing legislation is contained within Part 4 Taxation (International and Other) Provisions Act 2010 (TIOPA 10).

The UK Diverted Profits Tax legislation is contained within Part 3 Finance Act 2015 (FA 15).

The UK permanent establishment legislation is contained within section 5 and 19-32 of Corporation Tax 2009 (CTA 09) and sections 1141-1153 of Corporation Tax Act 10 (CTA 10).

Proposed revisions

Transfer Pricing

The draft legislation amends the UK transfer pricing rules at Part 4 Taxation (International and Other Provisions) Act 2010 in the following areas:

• the participation condition
• intangible fixed assets
• commissioners’ sanctions
• UK-to-UK transfer pricing
• financial transactions

The participation condition is amended to include:

• a new form of direct participation where two persons are subject to an agreement for common management
• an anti-avoidance provision ensuring participation when a person enters into arrangements with a main purpose of not meeting the participation condition
• a power allowing HMRC to issue a transfer pricing notice requiring a taxpayer who is under enquiry to file on the basis that there is participation

Intangibles — one valuation standard is applied for the transfer of intangible fixed assets. The arm’s length price will used where there are cross-border transactions between related parties that are in scope of Part 4 Taxation (International and Other Provisions) Act 2010. The market value will be used in all other circumstances. 

Commissioners’ sanction — the requirement for HMRC’s commissioners to sanction transfer pricing determinations is removed.

UK-to-UK transfer pricing — domestic transactions between UK companies are exempt from transfer pricing where there is no risk of tax loss.

Financial transactions — The changes relating to financial transactions will better align the UK rules with the guidance at Chapter X of the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines.

The draft legislation provides a definition of implicit support and requires that the effect of implicit support should be taken into account when applying Part 4 Taxation (International and Other Provisions) Act 2010. Explicit guarantees will also be taken into account, to the extent that they are considered to be arm’s length.

The amendments described above will result in consequential changes to the compensating adjustment rules in Chapter 4 and Chapter 5 of Part 4 Taxation (International and Other Provisions) Act 2010.

The draft legislation will include an improved rule that aggregates equity holding lenders for the purposes of determining indirect participation for financing transactions involving persons acting within the same arrangement.  

The draft legislation also includes rules to bring exchange gains and losses on loan relationships and derivative contracts into scope of Part 4 Taxation (International and Other Provisions) Act 2010, but without disturbing existing hedging arrangements. The one-way street will also be relaxed so as to not disallow debits that represent a reversal of a foreign exchange or fair value credit.

Permanent establishment

This measure proposes to align the UK domestic definition of a permanent establishment with the definition set out in Article 5 of the 2017 Organisation for Economic Co-operation and Development Model Tax Convention. 

It also seeks to revise the current domestic legislation on permanent establishment attribution contained in Chapter 4 Corporation Tax Act 2009 to align with Article 7 of the Organisation for Economic Co-operation and Development Model Tax Convention. This will be supported by the Commentary and the Organisation for Economic Co-operation and Development Report on the Attribution of Profits to permanent establishments.

In addition, the draft legislation includes a number of changes to the Investment Manager Exemption. The key changes are:

• the removal of the ‘if, and only if’ construction of the Investment Manager Exemption to ensure that it acts as a safe harbour and not as a mandatory alternative to the general agent exemption in section 1142 Corporation Tax Act 10
• the revision of the scope of the Investment Manager Exemption to cover a wider range of transactions conducted within a fund
• the removal of Condition D, ‘the 20% rule’, which has caused practical difficulties for taxpayers and which does not serve a clear purpose as an indicator of independence
• the removal of the charging provision in section 1152 Corporation Tax Act 10, which serves no practical purpose in the absence of the 20% rule

Alongside the draft legislation the government will publish a revised draft of Statement of Practice 1/01.

Diverted Profits Tax

This measure proposes to repeal Diverted Profits Tax and introduce a new charging provision for unassessed transfer pricing profits at Part 4A Taxation (International and Other Provisions) Act 2010. This would allow businesses to benefit from access to the UK’s treaty network including Mutual Agreement Procedure to remove double taxation.

The draft legislation intends to clearly link to transfer pricing principles as requested in the 2023 consultation responses. Additionally, the legislation sets out how the unassessed transfer pricing profits assessment process would operate, including the maintenance of the useful notice system from the Diverted Profits Tax regime and the removal of the notification requirement.  

The draft legislation retains the two gateway tests from the Diverted Profits Tax regime, the effective tax mismatch outcome and the tax design condition — previously, the insufficient economic substance condition. However, it seeks to considerably simplify these gateways and improve their functionality. It will still be possible for a company to amend its tax return to bring diverted profits into charge to Corporation Tax and reduce any associated Diverted Profits Tax charge.

Summary of impacts

Exchequer impact (£ million)

2024 to 2025	2025 to 2026	2026 to 2027	2027 to 2028	2028 to 2029	2029 to 2030
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The final costing will be subject to scrutiny by the Office for Budget Responsibility and will be set out at a future fiscal event.

Economic impact

This measure is not expected to have any significant macroeconomic impacts.

Impact on individuals, households and families

This measure is expected to have no impact on individuals as it only affects businesses.

Equalities impacts

It is not anticipated that there will be impacts for those in groups sharing protected characteristics. A full equality impact assessment is not recommended.

Impact on business including civil society organisations

This measure will have a negligible impact on businesses who are currently in the scope of UK transfer pricing, permanent establishment and(or) Diverted Profits Tax rules — it will simplify the UK’s tax rules, bring those rules up to date, and align them more closely with the UK’s obligations under double taxation treaties.

One-off costs could include familiarisation with the changes. Continuing costs for businesses should reduce and no additional administrative costs will be placed on businesses.

This measure will have no impact on civil society organisations.

Overall, this measure is expected to improve business’ experience of dealing with HMRC as the transfer pricing, permanent establishment and Diverted Profits Tax rules will be simpler.

Operational impact (£ million) (HMRC or other)

Some small changes will be required to HMRC IT systems, and that cost is currently estimated to be £770,000.

Other impacts

Other impacts have been considered and none have been identified.

Monitoring and evaluation

The measure will be monitored and assessed alongside other measures in the government’s International Tax reform package including:

• amendments to the transfer pricing small and medium-sized enterprise exemption
• cost contribution arrangements
• the international controlled transactions schedule

Further advice

If you have any questions about this change, please email dpt-tp-pe-reform@hmrc.gov.uk.