Introduction: Diverted Profits Tax and What Replaced It
The diverted profits tax no longer exists for current accounting periods, and almost every article you will find online still describes it as live. Furthermore, the replacement is materially better for American owners, for reasons nobody is explaining. Britain repealed the charge and rebuilt it inside corporation tax from 1 January 2026.
That structural move matters far more than it sounds. Moreover, it changes whether the charge reaches the US-UK treaty and whether it can produce a foreign tax credit. At TaxYork, we treat the reform as a planning opportunity rather than a technical footnote.
Why the Diverted Profits Tax Still Matters in 2026
Repeal is not retrospective. Specifically, the diverted profits tax continues to govern accounting periods beginning before 1 January 2026, and HMRC can still open those years. Consequently, most groups face both regimes simultaneously for the next several years.
The old rules also shaped the new ones. Additionally, the replacement retains both gateway tests and much of the assessment machinery. Therefore, understanding the original charge remains essential to understanding what you now face.
What Changed on 1 January 2026
Three things changed together. Firstly, the standalone tax disappeared. Secondly, an equivalent charge appeared inside the corporation tax code. Thirdly, and decisively, that charge became a covered tax for treaty purposes.
The rate survived almost unchanged. However, the payment timetable, the notification duty and the appeal route all moved. We work through each below, with the statutory references and the American consequences.
How the Diverted Profits Tax Worked
The original regime ran from 1 April 2015 until the end of 2025, and its design explains the reform.
The Two Gateway Tests
Two conditions opened the gate. Specifically, the effective tax mismatch outcome asked whether the counterparty's tax on the relevant payment fell below 80% of the UK tax reduction. Meanwhile, the tax design condition asked whether the arrangement was designed to reduce UK tax.
Both tests survived the reform intact. Furthermore, HMRC applied them to structures that were entirely commercial in origin. Consequently, the diverted profits tax caught arrangements that no adviser had regarded as aggressive.
The 31% Rate and Why It Was Punitive
The rate deliberately exceeded corporation tax. Specifically, it stood at 25% until April 2023, then rose to 31% alongside the increase in the main corporation tax rate to 25%. The six point premium was the point of the exercise.
That premium was meant to change behaviour. Additionally, HMRC published transfer pricing and diverted profits tax statistics showing far more yield from behavioural change than from the charge itself. Therefore, the tax functioned largely as a deterrent.
Pay First, Argue Later
The payment mechanics were brutal. Specifically, a charging notice required payment within 30 days, and postponement was unavailable on any grounds. No appeal could be made until after a fifteen month review period.
Cash left the business immediately. Moreover, it left before any tribunal had considered whether the diverted profits tax was due at all. Consequently, the charge operated as a commercial pressure point rather than a conventional assessment.
The New Unassessed Transfer Pricing Profits Charge
The replacement keeps the substance while changing the frame, and the frame is what matters.
Where the Rules Now Sit
Schedule 5 to the Finance Act 2026 inserts a new Part 4A into TIOPA 2010. The Act received Royal Assent on 18 March 2026, and the new charge applies to accounting periods beginning on or after 1 January 2026.
HMRC calls the result unassessed transfer pricing profits. Furthermore, its guidance on the transition explains how the two regimes overlap. Therefore, the acronym UTPP now appears where the diverted profits tax once did.
The Rate Is the Corporation Tax Rate Plus Six
The premium was preserved explicitly. Specifically, the UTPP rate is defined as the underlying corporation tax rate plus 6%. At the current 25% main rate, that produces 31%.
The definition is smarter than a fixed figure. Consequently, the premium now tracks corporation tax automatically, so a future rate change carries the charge with it. Additionally, the banking surcharge interacts with the calculation for affected sectors.
Notification Has Gone
One duty disappeared entirely. Under the old regime, companies had to notify HMRC within three months of the accounting period end, with penalties for failure. That notification requirement has been removed.
The relief is genuine but partial. Nevertheless, HMRC retains its own information powers and its enquiry window. Therefore, removing the duty reduces compliance cost without reducing exposure to the successor of the diverted profits tax.
Transparent Entities Get Longer
The timetable now recognises American structures. Specifically, a company has 30 days to make representations after a preliminary notice, extended to 60 days where the other party is a transparent entity. HMRC then has 60 days to assess, or 90 days in the transparent case.
That extension matters to our clients directly. Moreover, US LLCs and partnerships are precisely the transparent entities contemplated. Consequently, American-owned groups gain genuine breathing room that the diverted profits tax never allowed.
Payment and Limited Postponement
The payment rule improved materially. Instead of 30 days from a notice, the charge is payable under normal corporation tax rules, generally nine months and one day after the accounting period end. Late payment interest runs from that date.
Postponement also became possible, though narrowly. Specifically, the postponement provision permits deferral only where the other party has already paid tax on the same profits. Therefore, the pay-first principle survives in weakened form, and the assessment process otherwise mirrors the old one.
The Change That Matters Most to Americans
Here is the point that no UK commentary frames for a US audience.
Diverted Profits Tax Sat Outside the Treaty
The original charge was deliberately excluded from the treaty network. HMRC stated the position plainly in its reform consultation: the tax was not income tax, capital gains tax or corporation tax, and it was not covered by double taxation treaties.
The consequences were severe. Consequently, the mutual agreement procedure in the US-UK Convention, whose text the US Treasury also publishes, offered no route to relieve the resulting double taxation. Additionally, bilateral advance pricing agreements could not cover the diverted profits tax at all.
Why the Foreign Tax Credit Was Doubtful
American creditability was equally uncomfortable. Specifically, section 901 credits income, war profits and excess profits taxes, and the regulations test whether a levy reaches net gain in the American sense.
A charge aimed at specific profit-shifting outcomes sits awkwardly against that standard. Therefore, many advisers concluded that the diverted profits tax was not creditable, or at best contestable, on Form 1118. An uncreditable 31% charge is simply a cost.
What Treaty Access and MAP Now Deliver
Bringing the charge inside corporation tax changes the analysis. Notably, corporation tax is a covered tax under the Convention, so the mutual agreement procedure becomes available in the ordinary way. HMRC identified exactly this benefit when consulting on the reform.
The credit position should improve correspondingly. Nevertheless, we recommend confirming the treatment for your specific facts rather than assuming it, because the foreign tax credit still depends on the character of the levy. Consequently, the reform converts a probable absolute cost into a probable timing and basket problem, which is a very different conversation.
What the Reform Does Not Change
Optimism should stay bounded, because several hard edges survived intact.
The Gateway Tests Are Identical
Nothing about your exposure softened. Specifically, the effective tax mismatch outcome and the tax design condition carried across unchanged from the diverted profits tax. A structure that failed those tests in 2025 fails them in 2026.
The 80% mismatch measure also survived. Furthermore, HMRC still applies it to arrangements with genuine commercial roots. Consequently, the reform improved your remedies rather than narrowing the charge itself.
You Still Pay Before You Win
The pay-first principle weakened but did not disappear. Specifically, postponement remains unavailable except where the counterparty has already paid tax on the same profits. That exception is narrow, and it does not obviously extend to US federal tax paid by an American affiliate.
A fifteen month review period also remains. Therefore, the sequence still runs assessment, payment, review and only then appeal. Consequently, the cash-flow discipline that made the diverted profits tax effective is largely preserved.
Treaty Access Is a Route, Not a Result
Access to the mutual agreement procedure is valuable, though it guarantees nothing. Notably, competent authorities are obliged to endeavour to resolve a case, not to succeed. Cases routinely take years.
Plan accordingly. Additionally, a successful claim relieves economic double taxation but does not refund interest or advisory costs. Therefore, robust documentation still beats a good remedy, and the same discipline that supports your annual US tax return preparation supports the UK position too.
Who Is Actually in Scope
Most readers of this article are outside the regime, and knowing that is worth real money in avoided fees.
The SME Exemption
Small and medium enterprises never fell within the charge. Specifically, the exemption follows the familiar definition of fewer than 250 staff together with turnover not exceeding €50 million or a balance sheet total not exceeding €43 million.
The exemption carried across to the new rules. Therefore, an owner-managed group comfortably below those figures faces neither the diverted profits tax nor its successor. Additionally, that mirrors the transfer pricing exemption we cover in our guidance on treaty and structuring work.
The Ten Million and One Million De Minimis
Larger groups had a second escape. Specifically, exceptions applied where UK-related sales fell below £10 million, or UK-related expenses fell below £1 million, in a twelve month period. Those thresholds protected companies with genuinely limited UK activity.
The figures are not indexed. Consequently, inflation has quietly pulled more structures into scope each year. Meanwhile, a US group opening a modest London sales office can cross £1 million of UK expenses faster than expected.
Why Most of Our Clients Are Outside It
Honesty serves clients better than alarm. Specifically, the typical American founder, investor or executive we advise operates well beneath the SME ceiling. Therefore, neither charge applies to them at all.
That is not the end of the analysis. However, a different rule was written precisely to catch the businesses the diverted profits tax could never reach. We turn to it next.
Profit Fragmentation: The Rule That Does Catch You
This is the provision American owner-managers should actually worry about.
Where the Diverted Profits Tax Stopped and This Begins
Parliament noticed the gap and closed it. Specifically, Schedule 4 to the Finance Act 2019 counteracts avoidance involving profit fragmentation arrangements. It applies from 1 April 2019 for companies and 6 April 2019 for individuals and partnerships.
The scope is deliberately different. Notably, it reaches individuals, partnerships and small companies, all of which the diverted profits tax expressly excluded. Consequently, it functions as transfer pricing for businesses that believed they had an exemption.
The 80% Payment Test and the Enjoyment Condition
The mechanics echo the older regime. Firstly, the arrangement fails the 80% payment test where the increase in the overseas party's taxes is less than 80% of the reduction in UK tax. Secondly, an enjoyment condition asks whether a UK-related individual still benefits from the value transferred.
Both must be present, alongside an excessive allocation of profit. Furthermore, the counteraction adjusts the UK position to what it would have been at arm's length. Therefore, the analysis resembles section 482 in the US transfer pricing rules, applied to much smaller businesses.
Why American Owners Trip It
The pattern is familiar to us. Specifically, a UK-resident American runs a consulting or software business and routes part of the income through a US entity they also own. The US entity performs little, yet takes a substantial margin.
Enjoyment is obvious where the same person owns both. Consequently, HMRC has a straightforward argument, and the SME transfer pricing exemption provides no shelter. Additionally, the American side generates Form 5471 obligations that document the arrangement for anyone who asks.
Case Study: A US Group With a UK Sales Company
Consider an illustrative scenario drawn from work we see regularly.
The Facts
An American technology group sells software into Europe through a UK subsidiary. The UK company books £14 million of sales and pays a £9.2 million royalty to a US affiliate holding the intellectual property. UK taxable profit after the royalty is £1.1 million.
Group headcount exceeds 400, so the SME exemption is unavailable. Meanwhile, UK-related sales far exceed £10 million. Consequently, the group sits squarely inside the regime.
The Old Diverted Profits Tax Outcome
HMRC challenged the royalty for the year ended December 2024. Specifically, it argued that an arm's length royalty would have been £5.8 million, leaving £3.4 million of additional UK profit. The mismatch and design conditions were both met.
The charge landed at 31%, producing £1.054 million. Furthermore, payment fell due within 30 days with no postponement available. Critically, the group could not take the diverted profits tax to the mutual agreement procedure, and its US advisers declined to claim a credit for it.
The Position From 2026
The same facts in the year ending December 2026 look different. Firstly, the charge arises inside corporation tax at the same 31%. Secondly, payment follows the normal timetable rather than a 30 day demand.
Thirdly, and most importantly, the treaty now applies. Therefore, the group can pursue the mutual agreement procedure to eliminate the economic double taxation, and its credit position is materially stronger. The cash cost of the same dispute falls dramatically.
What to Do About Open Diverted Profits Tax Years
Legacy exposure deserves attention now rather than when a notice arrives.
Periods Still Governed by the Old Rules
Check your period ends carefully. Specifically, any accounting period beginning before 1 January 2026 remains subject to the diverted profits tax, including the treaty exclusion and the punitive payment terms. HMRC's enquiry windows extend for years beyond that.
Transition planning is therefore live. Additionally, HMRC's own guidance on the interaction confirms that both regimes will run in parallel for some time. Consequently, a group with a March year end faces the old rules well into 2027.
Documentation That Protects You
Contemporaneous evidence remains the best defence. Specifically, functional analyses, benchmarking studies and board minutes explaining commercial rationale all reduce the risk that the design condition is met. Furthermore, they support any later mutual agreement procedure claim.
Retrofitting rarely convinces. Meanwhile, the appeals and review guidance shows how narrow the grounds for representations are. Therefore, the work must be done before the notice, not after it.
Coordinating the US Filings
Both sides must tell one story. Specifically, the transfer pricing position disclosed to HMRC must match what appears on your US returns and information forms. Inconsistency is the single most common trigger we see.
Late filings compound the risk. Consequently, where American returns have slipped, we bring them current through the IRS Streamlined Filing Compliance Procedures before engaging with a UK enquiry. Additionally, we align both files so that neither authority finds a contradiction, including any foreign account reporting that runs alongside.
How TaxYork Can Help
We prepare US and UK filings for groups and owner-managers whose businesses operate on both sides of the Atlantic. Furthermore, we assess exposure under the successor to the diverted profits tax, the profit fragmentation rules and the transfer pricing regime together, because they overlap.
Our work covers transfer pricing documentation, exposure reviews under the new charge, mutual agreement procedure claims, foreign tax credit modelling, and the Form 5471 and Form 1118 reporting that accompanies US ownership. Additionally, we advise on legacy periods still governed by the old regime. Our team follows technical guidance from bodies including the ICAEW Tax Faculty, and we review HMRC's UTPP manual series as it develops.
Above all, we act before a notice arrives. Documentation prepared in advance costs a fraction of a dispute defended afterwards.
Conclusion
The diverted profits tax was repealed for accounting periods beginning on or after 1 January 2026 and replaced by a charge on unassessed transfer pricing profits inside corporation tax. Moreover, the rate premium survives at the corporation tax rate plus six points, so the headline cost is unchanged at 31%. However, the charge now reaches the US-UK treaty, which the old tax never did.
For American owners, that structural change is the whole story. Consequently, the mutual agreement procedure becomes available and the credit position improves substantially. Meanwhile, most owner-managed groups sit outside both regimes entirely, and should be looking at the profit fragmentation rules instead.
Contact Us
Speak to a specialist about your exposure under the successor to the diverted profits tax. To review your position confidentially, book a consultation with our cross-border team.
Email hello@taxyork.com or call 020 3488 8606.
Disclaimer
This article provides general information only and does not constitute tax advice. Tax rules change, and their application depends on your specific circumstances. Furthermore, no reader should act on the basis of this content alone. Obtain professional advice tailored to your situation. TaxYork accepts no liability for any loss arising from reliance on this material.