Permit to fly rules do not exclusively limit you to the UK, they do mean that you need permission to fly abroad. There's an ECAC (European Civil Aviation Conference) agreement quoted in CAA AN52 allowing you to fly in most European countries. You will be limited to day-VMC, but not necessarily to the UK (think of the couple of microlight pilots who have managed to fly around the world on permits to fly).
I don't know my way around the PFA system so well, but there's some useful odds an ends on the BMAA website at
http://www.bmaa.org/tech2.htm that may help, I'd particularly point out their TILS 018 and 029, and form 041 - my experience is that the PFA and BMAA are generally happy accepting each other's paperwork anyway for design submission backup. If you are a PFA member, they do have a lot of information sheets available you can request on their website.
You certainly don't need an "approved" engine, but the less experience the PFA have of the engine you're intending to use, the more information they'll ask for. There's an excellent ground running schedule that goes a long way to proving the viability of an engine in JAR-22.
Almost universal in automotive conversion, in my experience anyway, people have design an adaptor mechanism and used the Rotax C-type gearbox, which seems to work very well with BMW engines, etc.
I agree about Lycontinentals, give me a 912 any day.
G