Professional Partnerships: potential changes to international tax rules

Highlights from the Government’s consultation on reforming UK rules on transfer pricing and permanent establishments

Potential changes to TP and PE rules

The Government’s consultation seeking views on reforming the UK tax rules on transfer pricing, permanent establishments and Diverted Profits Tax closed on 14 August 2023. The main purpose of the consultation was to consider how the current UK tax rules relating to these areas can be updated to ensure clarity and consistency with international standards (mainly OECD), the UK’s double tax treaties (DTTs) and policy intentions. Professional partnerships are likely to be interested in the proposals relating to transfer pricing and permanent establishments.

A general overview of the consultation can be found in our earlier article.

Transfer pricing

The first part of the consultation dealt with transfer pricing (TP), which requires profits arising on transactions between connected parties to be calculated as if they had taken place between independent parties. The UK TP rules have hardly changed since 2004; however, since then, there have been major developments in the international tax environment (including changes to the OECD TP guidelines and updates to the OECD Model and its commentaries).

The consultation was seeking feedback on three main areas:

  • The ‘provision’ (the economic relationship between the two parties);
  • The ‘participation condition’ (how connectedness should be defined); and
  • The tax advantage rule (one-way street).

The aim is to promote certainty by aligning UK domestic law with the OECD Model and tax treaties.

The Government also invited comments on whether domestic transactions should continue to be caught by the TP rules. Any relaxation is likely to have exceptions, however, to ensure scenarios which have a detrimental impact on the UK tax base remain within the rules.

Permanent establishment

Where a foreign company carries on business in another country, this may create a permanent establishment (PE) in that other country and a corresponding taxable presence. DTTs include rules which determine which country has the primary taxing rights to avoid double taxation.

The Government is not planning any significant changes to these rules, however, the UK domestic legislation, which establishes the tax charge, was originally drafted in 2003 and reflected the PE principles in the OECD Model at that time. There have been a number of key international developments since then and the OECD approach has evolved. This has resulted in uncertainty around both the definition of a PE and the attribution of profits to a PE.

The Government is therefore considering updating the UK legislation in order to maximise certainty, allow greater flexibility in treaty negotiations and to maintain alignment with DTTs and the OECD Model as they develop further.

Some will be pleased to hear that the consultation specifically stated that there is an intention to retain the current exemptions for UK brokers and investment managers (treating them as independent agents when certain conditions are met).

What next?

Professional partnerships need to be aware of the proposals relating to transfer pricing and permanent establishments and start considering how they may impact their business.

We will not know further information until HMRC publish comments following their review of responses to the consultation.

Please contact the authors or your usual KPMG in the UK contacts if you would like to discuss these proposals further.