In June 2023, we discussed HMRC’s consultation on proposed reforms to the UK’s transfer pricing, permanent establishment (“PE”) and diverted profits tax (“DPT”) regimes. HMRC published their response on 16 January 2024 and suggests we can expect some important changes to these regimes in the near future.
Tax Litigation and Resolution partner Matthew Greene and associate barrister Guy Bud examine HMRC’s response.
Transfer pricing
Transfer pricing is a complex area, and the consultation’s aim “to clarify, simplify and improve the current rules” has a lot to commend it. A number of new ideas were floated that ranged widely in their scope and potential importance.
These included proposed changes to the “participation” condition, which is foundational to the existing transfer pricing regime. HMRC is concerned that the existing rules are too prescriptive and it is missing some arrangements that ought to fall within its scope. Instead, the consultation suggested some more expansive and impressionistic standards.
Many respondents (perhaps unsurprisingly) were concerned about this, but HMRC largely shrugged off these doubts. It has now committed to drafting legislation that will “address known problem cases in a targeted and prescriptive matter” while also “clarify[ing] other existing rules within the participation condition”.
Many other points dealt with specific areas of concern within the existing rules. It seems likely that some new exemptions will be created to bring certain UK:UK arrangements outside the scope of the transfer pricing regime. Other areas are likely to see them extended to new areas, such as the exchange of an asset for non-monetary consideration.
Although there is some scepticism as to whether the proposed alignment of “provisions” with the Organisation for Economic Co-operation and Development’s (OECD) preferred terminology (“conditions”) will increase rather than mitigate uncertainty, there will be a cautious welcome to HMRC’s commitment to proceed towards simplification in other areas, including in the context of the loan relationship and derivative contract regime. The government intends to do away with the commissioner’s sanction but will be looking to adapt existing safeguards. We can expect expanded guidance on the governance process.
Permanent establishments (PE)
The consultation proposed reform of the existing rules on permanent establishments to simplify and clarify the position for multi-national enterprises, with particular reference to bringing domestic and international concepts into greater alignment.
There is to be a technical consultation on draft domestic legislation relating to profit attribution to align the rules with the current version of Article 7 of the 2017 OECD Model Tax Convention.
A proposal to change the domestic definition of a PE has proven more controversial. HMRC has committed to “continue to consider” future changes. We expect to hear more about this in the future, but the timing is unclear.
Diverted profits tax (DPT)
One of the boldest points proposed in the consultation was removing DPT’s status as a separate tax and folding equivalent rules into the broader framework of corporation tax.
The consultation revealed support from a majority of respondents in view of the obvious administrative benefits for taxpayers. Some, not unreasonably, questioned whether there was any benefit in retaining DPT in any form, given recent changes in the international tax landscape and the impact of Pillar 2. Although unwilling to go this far, at least for the moment, HMRC clearly sees the merger of DPT with corporation tax as a key step towards its tax simplification agenda.
Next steps
The consultation is only an early indicator of reform. A technical consultation on draft legislation is scheduled, and more details will emerge then. Taxpayers may also be likely to receive more information about the governance process which will be welcomed by those already caught up in protracted transfer pricing enquiries.
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