UK Consults on Wide Reforms of International Tax Legislation

The UK tax authority, HM Revenue & Customs, recently published an ambitious and wide-ranging stakeholder consultation on reforming the UK’s legislation on transfer pricing, permanent establishment, and diverted profits tax.

This triumvirate of international tax rules is the primary means on which the UK’s claims to tax the profits earned by multinational enterprises have been based.

The overall intention of the consultation is to consider how domestic legislation in these areas can be modernized to support investment in the UK, and how to improve tax certainty and continued access to treaty benefits by developing simpler legislation that is easier to understand and aligns with OECD international standards and the UK’s bilateral tax treaties.

The consultation is open until August 14, and businesses are being encouraged to share their views.

Transfer Pricing Changes

The UK’s transfer pricing rules originate from legislation enacted in 1998, and the consultation represents the most significant reform since 2004. There has been huge change in the international and domestic approach to transfer pricing since the 2004 reform, and the general thrust of the changes HMRC is consulting on aims to address potential areas of friction between the UK law and Organization for Economic Cooperation and Development principles, and to explore additional ways in which the administration of the rules could be simplified.

The most interesting aspects of the proposals are:

Reintroducing a domestic exemption. The previous exemption was withdrawn in 2004 to comply with EU law, and HMRC is now looking at options to relax the rules for UK–UK transactions, which will be well received by large businesses. For those hoping for a return to the type of broad UK–UK exemption that existed pre-2004, this is unlikely.

Any relaxation is likely to have exceptions to cover scenarios in which the mispricing has a detrimental UK tax impact due to differences in effective rates of tax. The consultation specifically mentions situations where mispricing impacts loss utilization, income tax–corporation tax rate arbitrage, and where a special regime applies such as the banking surcharge, the oil and gas ring fence, or the patent box regime.

Overhauling transfer pricing rules for financing arrangements. HMRC is planning a major overhaul of the special rules for financing arrangements between companies. The OECD published transfer pricing guidance for financial transactions in 2020, and there is friction between this guidance and the UK rules, particularly in relation to the treatment of guarantees and “implicit support.” Alignment in these areas would be very welcome.

Changing the participation condition. HMRC is also inviting stakeholder feedback on whether simplifying changes can be made to the participation condition—the definition of connectedness used to identify which dealings are within scope of the rules. HMRC has been looking at the types of approaches other countries have adopted. The current UK rules are viewed as complex, but by being prescriptive and exhaustive they provide clarity and certainty in most cases.

The two problematic areas we expect to attract comments are the “acting together” rule that extends the scope of which parties are connected for financing arrangements, and joint venture arrangements where two members hold at least 40%.

While such arrangements can theoretically pose a risk of non-arm’s length pricing, in most cases, each investor will be acting purely in their own economic interest. Treating these transactions as between associated enterprises removes a potentially valuable source of comparables for assessing the arm’s length nature of intra-group transactions.

Interaction with other valuation approaches. There are various pieces of legislation, most notably the rules on taxing intangible fixed assets, where transfer pricing and market value concepts appear side by side. Transfer pricing is generally given priority but, in some instances, a market value override applies where this is higher.

This is arguably unnecessary complexity as, while transfer pricing and market value can give rise to different answers, where there is a difference it is transfer pricing that typically gives the higher amount. Giving priority to transfer pricing is beneficial, as this facilitates eliminating potential double taxation under the UK’s tax treaties.

Permanent Establishment

The UK domestic rules on PE were originally drafted in 2003, and the intention at the time was to reflect the OECD principles as they then stood. However, the situation has evolved considerably since, both in terms of what constitutes a PE and the OECD-endorsed approach to attributing profits to a PE.

Changes to the OECD model treaty article that defines what level of presence constitutes a PE was one of the outcomes of the OECD’s BEPS Project. The UK chose not to adopt all the changes put forward by the OECD, most notably opting out of changes relating to the dependent agent PE conditions.

HMRC is now considering changing its tax treaty negotiating policy, allowing treaties to be aligned with the 2017 OECD model. It is also assessing changes to the domestic legislation on PEs to align with the terms of bilateral treaties and, in non-treaty situations, to take the OECD model as the starting point. The intention is to deliver a simplified regime for multinational enterprises, increasing tax certainty for nonresident entities trading in the UK.

HMRC has indicated that the exemptions for UK brokers and investment managers will be retained, which should be reassuring for the UK insurance and asset management sector.

Diverted Profits Tax

DPT was introduced in 2015 to counter the use of “contrived and artificial arrangements” and HMRC statistics suggest a yield of over £8 billion ($10.3 billion) can be attributed to DPT between 2015 and 2022.

The core issue that the UK government is considering is whether to bring DPT into corporation tax. It is intended that this will clarify the relationship between DPT and transfer pricing and importantly provide access to procedures for obtaining relief from double taxation under the UK’s tax treaties.

Other essential features of the regime, including the higher rate (31% from April) and requirement for advance payment of tax liabilities, are expected to be maintained, with some technical clarifications also proposed.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Phil Roper is director, global transfer pricing services and Tim Sarson is partner, UK head of tax policy, with KPMG.