Reform of UK Transfer Pricing, Permanent Establishment and Diverted Profits Tax — Consultation Outcomes

The UK is introducing a substantial reform of its UK Transfer Pricing, Permanent Establishment and Diverted Profits Tax framework, with most changes applying from 1 January 2026. The aim is to simplify legislation, improve alignment with OECD standards, and reduce compliance burdens, especially for UK-to-UK transfer pricing. Businesses operating internationally (or investing into the UK) should assess their governance structures, intercompany agreements and Transfer Pricing documentation before the new rules are enforced. A strategic review in 2025 may help mitigate risk and align processes ahead of the reform.

Introduction

The UK government has now published the results of the consultation “Reform of UK law in relation to transfer pricing, permanent establishment, and Diverted Profits Tax (DPT)”, which ran between 28 April and 7 July 2025. This was a detailed technical consultation following the policy-level consultation initiated in 2023.

Over 150 stakeholders participated in public events, and 45 written responses were received from major law firms, tax advisors, representative bodies and multinational businesses. The feedback has shaped the final draft of the legislation, which will be included in the Finance Bill 2025–2026, with most measures applying to accounting periods commencing on or after 1 January 2026. Certain amendments concerning financial transactions will include transitional rules.

The reform aims to modernise and simplify UK legislation, align it further with OECD standards, and provide greater clarity around the practical application of existing UK Transfer Pricing and Permanent Establishment principles, an area that has often been complex and fragmented.

If you want to learn more about these topics, check out our comprehensive guide on UK CFC Rules and Transfer Pricing here.

Key Areas of Reform

1. UK Transfer Pricing Framework

One of the most debated topics was the ‘participation condition’, which determines when two entities are considered sufficiently connected for transfer pricing rules to apply. Stakeholders argued that the initial draft created uncertainty and could unintentionally affect commercial arrangements such as franchise networks, investment funds or professional alliances.

As a result, the definition of “common management” has been significantly narrowed. The final draft focuses only on structures where there is (i) a legal arrangement, (ii) unified senior management, and (iii) shared economic outcomes through a defined mechanism. HMRC will publish examples in the guidance to help establish the boundaries of this provision.

HMRC will retain the power to issue UK transfer pricing notices based on Article 9 of the OECD Model Tax Convention, although the legislation will clarify that such notices apply only to the current accounting period and future periods. The anti-avoidance rule based on a “main purpose” test will also remain in place, supported by practical guidance when issued.

A major change widely welcomed was the repeal of UK-to-UK transfer pricing, which is considered a meaningful simplification that should reduce compliance burdens without creating material fiscal risk for HMRC. However, the exemption includes important exclusions, particularly in the financial services sector. HMRC will also retain the ability to disapply the exemption – but only when necessary to prevent a net loss of UK tax. Guidance will specify when this may occur and who within HMRC will exercise these powers.

Several technical clarifications have also been provided. Notably:

• “Same rate of tax” is understood to mean the statutory rate.
• The term “reference currency” is deliberately broader than “functional currency”, as it must reflect the currency used to calculate taxable profits in certain situations — particularly where foreign branches are involved.

2. Intangibles and IP Transactions

There was clear support for moving to a single valuation standard, with ‘market value’ being used for domestic transactions. This change is expected to improve consistency with other UK tax regimes. However, the existing ‘one-way street’ rule for licence arrangements (which prevents double non-taxation) will remain in place, at least initially. The government has agreed that the rule may require review in future, but the focus at this stage is on clarifying valuation standards.

Concerns were also raised regarding the assumption, in current legislation, that consideration for IP must always be monetary. HMRC agreed to clarify through guidance that this rule only applies when consideration is non-monetary, and does not apply where no consideration is paid in commercial royalty-free licensing arrangements.

3. Financial Guarantees and Compensating Adjustments

The alignment of UK rules on financial guarantees with Chapter 10 of the OECD UK Transfer Pricing Guidelines was broadly welcomed. Stakeholders asked for more detailed guidance on how compensating adjustments and elective guarantees will interact with the UK–UK exemption, and HMRC has confirmed this guidance will follow.

The government has also introduced more flexibility for section 153B elections, allowing additional time for taxpayers to make the election where circumstances change. Transitional rules have been extended to a period of up to two years, providing time to adjust pricing models and align legacy arrangements with OECD principles. Businesses will be able to opt into the new regime early via election.

4. Permanent Establishment – Closer Alignment with OECD Standards

There was strong support for aligning the UK definition of PE with the OECD Model Tax Convention and Commentary. The legislation will now replicate OECD wording more precisely, particularly in relation to attribution of profits.

Certain terms – such as “almost exclusively” and “plays the principal role” – will be clarified in future HMRC guidance. The government has confirmed that the legislative definition of “control” and how it interacts with the concept of “closely related enterprises” is consistent with OECD Commentary and will be further explained in the International Manual.

Changes to the Investment Manager Exemption (IME) were also refined following feedback. The government has broadened the definition to ensure that:

• It continues to cover situations already in scope, and
• it now also applies to investment advisors, not only investment managers.
• The Statement of Practice 01/01 will be updated before the legislation comes into force.

5. Diverted Profits Tax (DPT) – Replaced by UTPP

One of the most impactful changes is the withdrawal of Diverted Profits Tax as a separate tax and its replacement with UTPP (Unassessed Transfer Pricing Profits). This marks a structural shift that brings anti-avoidance provisions fully within the UK transfer pricing framework — allowing access to treaty relief mechanisms, including MAP.

The intention is for UTPP to retain the scope and targeting of the existing DPT regime, but be applied in a more efficient way within the overall UK Transfer Pricing framework. Stakeholders welcomed this step, particularly the possibility of using MAP in cases of double taxation.

The Profit Diversion Compliance Facility (PDCF) — regarded as a useful practical tool – will be retained and revised alongside UTPP legislation.

The Tax Design Condition, replacing the DPT’s “Insufficient Economic Substance Condition”, has been fine-tuned to ensure that it only applies where there is a clear intention to erode the UK tax base, rather than to commercial arrangements with incidental tax outcomes. The government resisted proposals to replace the term “designed” with “contrived”, considering the latter too narrow and potentially ineffective.

Looking Ahead

The reforms will form part of the Finance Bill 2025–2026. Most changes will apply from 1 January 2026, with transitional arrangements for financial transactions.

HMRC will now focus on updating the International Manual and revising the Statement of Practice 01/01, which will provide crucial operational guidance before the revised rules are enforced.

In practical terms, international groups operating in or trading with the UK should use 2026 as a window of alignment and risk assessment. Reviewing governance structures, intercompany agreements, supply chains, agency activities and IP arrangements will be essential to ensure compliance with the updated framework, particularly given the wide scope of the UK Transfer Pricing reform, and to take advantage of the greater clarity being offered.