On 28 April 2025, the UK government launched a consultation (the "Consultation") on proposed legislation to reform the UK's transfer pricing ("TP") and permanent establishment ("PE") rules, including changes to the investment manager exemption ("IME") and a repeal of the diverted profits tax ("DPT") regime.
These reforms build on a consultation initiated in 2023 (the "2023 Consultation") and are part of the UK government's approach to more closely align a number of these UK tax provisions to the 2017 version of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention. The Consultation closes on 7 July 2025, with legislation expected to be included in the Finance Bill 2025–26 and to be effective from 1 January 2026.
Permanent Establishment and the Investment Manager Exemption
The UK government proposes to reform the UK domestic definition of PE to more closely align with Article 5 of the 2017 OECD Model Tax Convention and reflect the "international consensus on the definition of a permanent establishment and the attribution of profits to a permanent establishment".1 Broadly, a UK PE is identifiable where there is a fixed place of business in the UK or a UK-located dependent agent PE ("DAPE"). Under current UK domestic tax law, a DAPE arises where"an agent has and habitually exercises authority [in a territory] to do business on behalf of the company". By contrast, under the proposed legislation a DAPE will arise where "a person acting on behalf of the company habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts, that are routinely concluded without material modification by the company".2 The proposed changes to the UK domestic definition of a PE do not affect the operation of any of the UK's double taxation treaties.
The revised definition is focused on contract conclusion and tracks the definition of a PE in the 2017 OECD Model Tax Convention. The new definition dispenses with the current UK wording which asks whether an agent has "an authority" to act on behalf of a non-UK resident person. Instead, the revised wording is potentially wider, focusing on whether the contract conclusion or negotiation is habitually located in the UK. Furthermore, the proposed reforms suggest that the exemption for agents of an independent status is narrowed, so that "independence" is absent where the agent "acts exclusively, or almost exclusively" for a "closely related" person.3 "Closely related" in this context includes where one person controls another, or where both are under common control.
Respondents to the 2023 Consultation raised concerns that the proposed broader definition of PE could place a greater strain on the practical application of the IME, which is the domestic exemption for investment managers to be considered an agent of independent status. To limit that risk, the UK government has proposed a number of amendments to the IME. First, the draft legislation removes the "if and only if" formulation in section 1142 CTA 2010 clarifying that the IME operates as a safe harbour rather than a statutory (and therefore mandatory) alternative exemption to the general independent agent exemption. Second, the definition of "investment transactions" within the scope of the IME is expanded which potentially allows a wider range of fund activity to qualify under the IME, albeit that this change is accompanied by a number of (unwelcome) restrictions in the proposed legislation which, if enacted, would limit the application of the IME to non-residents meeting the regulatory definition of an "investment fund". Third, there is a proposal to remove the "20 per cent. test" in the IME (at section 1146(6) CTA 2010) which has been criticised for causing practical difficulties for taxpayers and not serving a "clear purpose as an indicator of independence".4
Accompanying these legislative proposals are a number of proposed revisions to Statement of Practice SP 1/01, which offers guidance on the application of the IME. These revisions include significant changes that relate to the application of the "independent capacity" test, which is a key requirement of the application of the IME. The guidance clarifies that "qualifying funds" under the Qualifying Asset Holding Companies regime meet the independent capacity test. But not all the proposed revisions are helpful: the UK government has proposed that the substantial services safe harbour in Condition C of the IME now apply at 50 per cent. rather than 70 per cent., with the change being aimed at ensuring that the IME does not exempt any funds which are not genuinely independent.
The draft legislation also proposes to amend the UK rules on attribution of profits to a PE to bring them further in line with the 2010 OECD Report on the Attribution of Profits to Permanent Establishments.
DPT
The Consultation also sets out proposals to abolish the standalone DPT regime and introduce a new Unassessed Transfer Pricing Profits ("UTPP") charge which is integrated into the general corporation tax charge under Part 4A of Taxation (International and Other Provisions) Act 2010 ("TIOPA 2010"). The DPT was designed to deter aggressive tax planning by multinationals by imposing a higher tax rate (at 31 per cent.) than corporation tax to profits which are artificially diverted from the UK.
The UTTP retains many of DPT's procedural features. Notably, the new UTPP charge to UK corporation tax will operate on a "pay to play" basis. This would mean a company must settle the full tax liability before it is able to challenge the assessment or seek a repayment.
The UTTP charge can arise where two newly defined gateways are met. The first is the Effective Tax Mismatch Outcome ("ETMO"). The ETMO would be met for a provision between a company and a related party where foreign tax charged on the profits from the provision is less than 80 per cent. of the amount of UK corporation tax rate that would be charged on the profits to which the unassessed transfer pricing profits relate. Where the other party is a partnership, the draft legislation proposes that the ETMO would be presumed to be met and includes an additional period of time to provide evidence to the contrary.
The second gateway is the Tax Design Condition ("TDC") which proposes to replace the "insufficient economic substance" under DPT. The TDC would be met if it is "reasonable to assume" that arrangements were "designed to have the effect of reducing, eliminating or delaying the liability of any person to pay any tax (including any non-UK tax)".5
Transfer Pricing
The draft legislation in the Consultation makes several amendments to UK's TP rules. The proposals expand the "participation condition" that determines whether two entities are "connected" for TP purposes. Under the new rules, the test includes entities under "common management" or acting together in a concerted manner. HMRC will also have extended powers to issue transfer pricing notices in tax avoidance contexts.
The Consultation proposes the introduction of an exemption from transfer pricing for UK-to-UK transactions. Intra-group transactions between UK corporate taxpayers subject to the same rate of corporation tax will be exempt from transfer pricing adjustments where elected by either the taxpayer or HMRC. However, this new exemption will be supplemented by a list of exclusions to prevent opportunities for tax arbitrage.
The proposals also address the treatment of financial transactions. The new legislation incorporates Chapter X of the OECD Transfer Pricing Guidelines directly into UK law addressing intra-group guarantees, implicit support from a wider group arrangement, and compensating adjustments.
The draft legislation formally codifies the arm's length principle in line with the OECD Transfer Pricing Guidelines ensuring greater certainty and coherence.
Practical Implications
The Consultation represents a realignment of some of the UK's most important international tax rules alongside the OECD standards. The proposed changes to the UK's PE rules, and particularly the wider scope of the DAPE test, would lower the threshold for creating a UK taxable presence. As a consequence, there is a risk that this may increase the uncertainty for businesses with UK-based operations or agents. Businesses will need to carefully review agency and management arrangements to ensure they do not inadvertently fall within the widened PE net, particularly where management is being provided in situations where there is some ownership participation by a UK-based manager in the non-resident.
The replacement of DPT with an integrated UTPP regime aims to deliver procedural clarity. Questions nevertheless remain over the breadth of the UTPP gateway tests and the interpretation of new thresholds which may ultimately be shaped by tax authority guidance and the decisions of the UK courts in the future. The proposed reforms will require businesses to revisit structures, governance and transfer pricing positions to manage any increased UK tax risk.
Footnotes
1. Section 3 (Permanent Establishment) of the Consultation.
2. Proposed amendment to section 1141(1)(b) of the Corporation Tax Act 2010 ("CTA 2010").
3. Proposed amendment introducing a new section 1141(1A) CTA 2010.
4. Section 3 (Permanent Establishment) of the Consultation.
5. Section 217E(1) TIOPA 2010.
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