Finance Bill: Reform of international tax rules

Financing arrangements

For many MNEs the most important aspect of TP reform relates to the alignment of the rules on financing arrangements with OECD principles. The changes in the Finance Bill will make it unambiguous that implicit support to a borrower’s credit quality from its group should be taken into account; and explicit guarantees will also be taken into account, to the extent they would lower the rate of interest at arm’s length, but not to the extent they increase the quantum borrowed.

The Finance Bill confirms that the key amendments relating to financing arrangements will have immediate effect for borrowing occurring on or after 1 January 2026 with a longstop date two years after the commencement of the new rules when all loan provisions will be subject to the new rules. Taxpayers will be allowed to make an election in their tax return to adopt the rules early for existing loan provisions, enabling earlier alignment with OECD principles where this is desirable.

One of the favourable changes is the introduction of a new section 153B election, which allows a UK company outside the borrowing unit of a thinly capitalised UK borrower to elect to be taxed as if it provided a guarantee over all or part of the non-arm’s length element of the borrowing, enabling excess borrowing capacity in other UK companies (e.g. a UK sister company) to be accessed. This is a simpler and more certain alternative to the existing section 192 claim, which is retained. Based on responses to the technical consultation, the legislation now allows additional time for taxpayers to make a section 153B election – it must be made within four years of the end of the accounting period of the borrower, but if HMRC issue a discovery assessment a claim can also be made within one year of its issue.

The new rules are not without their complexities and HMRC are intending to publish guidance on how the new rules on financial guarantees would operate, specifically how the compensating adjustment, elective guarantee, and UK-UK exemption rules will interact.

Exchange gains and losses

The Finance Bill also includes rules to bring exchange gains and losses on loan relationships and derivative contracts within the scope of the TP rules, but without disturbing existing hedging arrangements. The one-way street will also be relaxed so as to not disallow debits that represent a reversal of a foreign exchange or fair value credit. Some helpful amendments have been made to the legislation previously consulted upon based on suggestions received from respondents.

Participation condition

The participation condition defines which persons are associated with one another for the purposes of the TP rules. The Government is moving ahead with three changes that are expected to widen the scope of the TP rules: 

• A new form of direct participation where two persons are subject to an agreement for common management and it is reasonable to suppose this results in a prescribed alignment of economic interests. The concept of common management has been substantially narrowed in the updated legislation so it only targets structures with a legal arrangement, a unified senior management, and shared economic outcomes through a defined mechanism. HMRC plan to issue guidance providing further detail on the types of structures that may be within scope;
• An anti-avoidance provision ensuring participation when a person enters into arrangements with a main purpose of not meeting the participation condition; and
• A power allowing HMRC to issue a transfer pricing notice requiring a taxpayer to file on the basis that there is participation where there would be participation under Article 9 of the OECD Model Tax Convention. The legislation has been amended to clarify that such notices only apply prospectively in relation to the chargeable period in which it is given and subsequent chargeable periods.

The ‘acting together’ provisions extend the circumstances when enterprises are treated as associated specifically for financing arrangements and were previously ill defined and seemingly very broad in scope. The Finance Bill includes welcome changes to clarify the scope of the acting together provisions and HMRC intend to publish additional guidance to clarify certain terms and points of uncertainty flagged in consultation responses.

Exemption for UK-UK transactions

The Finance Bill includes provisions exempting certain UK to UK transactions from TP obligations. There are no major changes to the exemption from the draft legislation previously consulted on despite respondents raising concerns over the complexity of the exemption and necessity for some of the exclusions from the exemption, particularly with respect to financial services sector companies and companies with minor activities in excluded regimes.

A change has been made to HMRC’s power to issue notices which disapply the exemption to clarify that HMRC will give a notice only if it is necessary to avoid a net loss of UK tax. HMRC will confirm in guidance when such notices may be issued and the personnel with oversight and responsibility for those decisions.

There are consequential amendments to the Loan Relationships and Derivative Contracts rules to prevent avoidance opportunities which may otherwise arise from the UK-to-UK exemption where there are amounts arising from loan relationships or derivative contracts treated as relating to capital expenditure. The amendments restrict the application of s320 and s604 CTA 2009 (which allow immediate relief for capitalised amounts) so as to exclude capitalised amounts which arise from transactions on non-arm’s length terms, i.e. amounts representing the difference between the fair value of the loan relationship or derivative and the (non-arm’s length) transaction price.

Transactions involving intangible fixed assets

The Finance Bill also brings some clarity to the valuation of related party transactions involving intangible assets. The rules in this area currently require the application of a market valuation standard and where the TP rules are applicable a further analysis comparing the actual provision with the arm’s length provision. The aim of the new rules is to move to a single valuation standard. The expectation is that this should reduce the compliance burden on taxpayers and better align the outcomes from the UK legislation with that from treaties (as Mutual Agreement Procedures, including Advance Pricing Agreements, can only determine questions under transfer pricing and not market value).

From 1 January 2026, a single valuation approach will be implemented for transactions entered into from that date. For transactions within the scope of the transfer pricing rules and which meet the definition of a ‘cross-border’ transaction then the arm’s length principle will apply, whilst for all other transactions market value should apply (including to any other transactions also within the scope of transfer pricing). ‘Cross-border’ is defined in the Finance Bill as where the related party is, broadly, either a foreign permanent establishment, a non-UK resident company, a non-UK resident individual, or a partnership whose members are all non-UK resident. The Finance Bill has not changed significantly from the proposed draft legislation prepared for consultation earlier this year, however the addition of a partnership whose members are all non-UK resident within the definition of ‘cross-border’ is new.

The new legislation has retained a ‘two-way street’ for transfers of intangible fixed assets, and a ‘one-way street’ for the grant of a licence which is not easy to rationalise given a transfer and a licence can be economically comparable and achieve identical commercial outcomes.

There are also other corresponding amendments for the use of the arm’s length principle in cross-border realisations of intangible assets where there are non-monetary receipts and where there is nil or negligible accounting value. Whilst the Finance Bill clarifies which value to use in these cases the rules are lengthy and complex and, at the time of writing, we are expecting some further guidance will be provided by HMRC to explain how these rules apply in specific circumstances.

It should also be noted that the market value test under the capital gains legislation may still be relevant where there is a cross-border transfer of assets created or acquired before 1 April 2002, in particular goodwill (on the transfer of a business or part of a business), trademarks and brands. Additionally, there are complexities around the treatment of intangibles, including where they may have previously moved around a group or in and out of the UK tax net. This means it will remain important to establish up front precisely what is transferring (specific intangibles only or all or part of a business carried on by the transferor), and the intangibles’ history.

New compensating adjustment provision

The Finance Bill introduces a mechanism for a UK-resident company to make a compensating adjustment when a TP adjustment is made to a connected foreign company that relates to a UK PE. This was not previously part of the consultation on draft legislation but is a welcome change which removes a potential bear trap.

The Finance Bill includes legislation which aligns the UK domestic definition of a PE with the definition set out in Article 5 of the 2017 OECD Model Tax Convention (OECD MTC). This is welcome news particularly given the recent updates to the OECD MTC Commentary that provide greater clarity on the treatment of remote working arrangements.

The measure also revises the current domestic legislation on PE profit attribution to align with Article 7 of the OECD MTC, which is supported by the MTC Commentary and the OECD Report on the Attribution of Profits to permanent establishments (AOA). This change only applies for inbound PEs (i.e. non-UK resident companies with UK activities); the Government has not changed the equivalent language for outbound PEs which was a point raised during consultation.

Changes have been made following the technical consultation to amend the draft legislation so that it directly replicates the wording of the OECD MTC and there were some further changes to the Investment Manager Exemption and Statement of Practice 1 (2001) in response to consultation feedback. HMRC also plan to issue additional guidance on the new legislation next year.

Replacement of DPT with Unassessed Transfer Pricing Profits rules

The Finance Bill includes legislation repealing the Diverted Profits Tax and introducing a new Corporation Tax charging provision for unassessed transfer pricing profits (UTPP). The new regime is simpler and, as the charge is to Corporation Tax at a higher rate six percent above the main rate, businesses can benefit from access to the UK’s treaty network in the usual way, including access to the Mutual Agreement Procedure to remove double taxation. 

The UTPP rules are anchored on TP principles and whilst they retain the notice system from the DPT regime the taxpayer notification requirement is gone. The UTPP does not include a Relevant Alternative Provision concept, which was a unique feature of DPT that made it easier for actual transactions to be disregarded compared to the relatively high bar in the OECD TP Guidelines that will apply under UTPP. UTPP, like DPT, seeks to encourage taxpayers to voluntarily amend the corporation tax return to bring additional profits into charge to Corporation Tax and thereby reduce any associated UTPP charge accordingly.

The UTPP regime retains the two gateway tests used for the DPT regime - the effective tax mismatch outcome (ETMO) and the tax design condition (previously, the insufficient economic substance condition) but looks to simplify these gateways and improve their functionality.

Changes to the ETMO were welcomed as they are less hypothetical and look at the actual tax liability of the counterparty. Most of the feedback on the draft legislation published for consultation centred on the tax design condition, which was considered too broadly drawn. In response the Government has amended the Tax Design Condition so that it only applies to designs which aim to erode the UK tax base. However, calls to replace the term ‘designed’ with ‘contrived’ were resisted as the Government considers that ‘designed’ is the appropriate term as the word ‘contrived’ would set the bar too high and may incentivise some businesses to introduce a nominal commercial element, or elements into a tax avoidance arrangement to circumvent the legislation. The Government response to the consultation notes that “a design is a deliberate plan, by a designer, to achieve a particular effect, whereas contrived implies an element of artifice or sham.”

We understand that HMRC plan to maintain the Profit Diversion Compliance Facility and intend to update the existing guidance following the introduction of UTPP.

We recommend that MNEs perform an impact assessment to review how the reforms, especially those effective for accounting periods beginning on or after 1 January 2026, will affect your group’s UK tax position, including both risks and opportunities. Some specific areas to consider are listed below:

1. Review and update financing arrangements
   • Assess intra-group financing structures to ensure alignment with the revised rules, particularly regarding implicit group support and explicit guarantees;
   • Consider the timing of new borrowings and whether to early adopt the new rules for existing loans; and
   • Evaluate the potential benefits of the new section 153B election for UK companies outside the borrowing unit.
2. Reassess any transactions where there is uncertainty over whether they are within the scope of UK TP rules
   • Review group structures and management arrangements in light of the broadened participation condition and anti-avoidance provisions; and
   • Identify any arrangements that could be caught by the new "common management" test or where the uncertainty has been clarified by the updated ‘acting together’ rules.
3. Evaluate UK-UK transactions
   • Identify transactions between UK group entities that may qualify for the exemption from TP; and
   • Consider if there is any benefit to electing out of the UK-UK exemption.
4. Review transactions involving intangible assets
   • Assess related party transactions involving intangibles to ensure compliance with the new single valuation standard and the updated definition of ‘cross-border’ transactions; and
   • Consider the impact on APA and MAP strategy, e.g. with respect to exit charges.
5. Consider exchange gains and losses
   • Review hedging and foreign exchange arrangements to understand the impact of bringing exchange gains and losses within the scope of TP.
6. Prepare for PE changes
   • Reassess the existence and profit attribution of UK PEs in light of the alignment with the 2017 OECD MTC; and
   • Consider the impact of changes on remote working arrangements and investment management activities.
7. Understand the replacement of DPT with UTPP
   • Familiarise your tax team with the new UTPP regime and its gateway tests; and
   • Review any arrangements previously within the scope of DPT to determine if they will be affected by UTPP.
8. Monitor HMRC guidance and further developments
   • Stay alert for forthcoming HMRC guidance on key areas such as financial guarantees, participation conditions, acting together and intangible asset transfers; and
   • Be prepared to adjust compliance processes as further details emerge.