On 29 March 2017, the UK Government served formal notice under Article 50 of The Treaty on European Union to terminate the UK's membership of the EU (following the June 2016 UK referendum on EU membership). Based on Article 50, the EU Treaties shall cease to apply to the UK and the UK exit will take effect in March 2019 (subject to the unlikely possibility of the withdrawal agreement being concluded sooner and unless all Member States agree to extend the period). Negotiation of a new trade agreement with the EU could take several years beyond 2019 although the Prime Minister has declared the objective of achieving such an agreement within the two-year period.
This briefing note anticipates how a Brexit will impact on tax law and the implications for companies doing business with and within the UK.
The key question is what the various agreements that will govern UK-EU relationships after an exit will look like. Three main post-Brexit models appear possibilities, based on how other non-member nations interact with the EU (see panel 1). The net effect of a Brexit will depend on which model is adopted and the trade agreements reached.
Panel 1: Post-Brexit models
|Three main models of EU interaction seem the most likely scenarios for a post-Brexit UK:
|Norwegian model: Norway is a member of the European Free Trade Association (EFTA), giving it access to a network of global free trade arrangements and the right to be a party to the European Economic Area Agreement. Parties to the EEA Agreement are included in the EU single market and must comply with its rules and restrictions, including the four fundamental freedoms: movement of goods, workers and capital and provision of cross-border services. The EU has said this model only works properly if parties adopt these internal market obligations fully, which means the UK would be unlikely to succeed in negotiating any derogations.
|Swiss model: Switzerland is also a member of EFTA, but is not party to the EEA Agreement. Instead, it accesses the EU single market via a regularly updated bilateral agreement. The EU has, however, called the Swiss model unwieldy and indicated that further arrangements of this kind may not be tolerated.
|Canadian model: Various other nations have opted to form relationships with the EU and its member states via the agreements and decisions of the World Trade Organization, of which the UK is already a member, the General Agreement on Tariffs and Trades and additional negotiated trade agreements. A post-Brexit Britain will also continue to be a member of the OECD, G20 and WTO, which are increasingly powerful forums for harmonising international trade and business practices.
The UK Government has indicated that it will freeze into UK law the EU legislation in force at the point of the UK's exit to ensure continuity, but may choose to amend such law in due course. This freedom will be limited to a greater or lesser extent depending on which model of EU interaction is adopted and the strength of the UK's negotiating position (which will be weaker if Scotland and Northern Ireland break away, as they have threatened to do). Similarly, UK courts may continue to have some regard to decisions of the CJEU, and adopt its purposive approach to interpreting legislation, in relation to laws with an EU origin.
This article seeks to clarify how the UK's tax framework might change when Brexit occurs, and what steps businesses can take now to mitigate risks and capitalise on gains.
VAT, excise duties and other indirect taxes
VAT is chargeable on most goods and service supplies within the EU. The law is fairly harmonised, although member states have a degree of discretion over rates and collection methods. Furthermore, the UK has been granted derogations allowing the zero-rating of certain classes of goods. Customs duties on imports into the single market are also harmonised, and EU law prevents taxes being levied on the raising of capital. Indeed, a past attempt to impose a stamp duty charge on certain share issues in the UK was ruled contrary to EU law.
A departure from the EU will simultaneously restore the UK's sovereignty over tax-setting and potentially end its access to the single market. In theory, then, the UK will gain the power to overhaul its tax system but will become subject to additional taxes, such as duties on importing into the EU.
In reality, little may change. VAT forms a sizeable part of the UK's tax intake and there will be little benefit in deviating significantly from the existing, EU-derived system, save perhaps creating further exemptions or rates for particular classes of goods. If the UK joins the European Free Trade Association, like Norway or Switzerland, it will benefit from a special customs procedure that suspends customs and excise duties and VAT on goods that pass through the UK en route to an EU destination. Further tax reliefs could be negotiated via bilateral trade agreements. HMRC will have more freedom to apply stamp duty to certain share issues, but moves of this kind are unlikely from a practical perspective.
Loss of influence over EU policy may impact UK business in the longer term. For example, the proposed EU-US Transatlantic Trade and Investment Partnership (TTIP) includes plans to remove customs duties and other barriers to trade between the EU and US. The US has indicated it might not seek separate UK agreements in the event of a Brexit, which could have a negative impact on UK-US trade.
Tax on company profits and capital gains
A Brexit will end the UK's obligations and rights under various EU laws designed to reduce the burden of direct tax for companies doing business across the single market. The Parent-Subsidiary Directive simplifies profit distributions between EU group companies by preventing double taxation and abolishing withholding taxes on dividend payments. The Mergers Directive simplifies the reorganisation of groups based in more than one EU member state, while the Interest and Royalties Directive removes withholding taxes on intra-EU interest and royalty payments between associated companies.
All of these Directives are enacted via legislation which, from the UK side, is likely to remain in place post-Brexit. Additionally, tax treaties have a significant crossover with some of these rules, and will remain in place post-Brexit. However, as these tax rules will over time diverge from EU rules, taxation will inevitably become more complex and burdensome for MNEs that have group companies in both the UK and EU. The UK will also lose its protection against discriminatory tax measures being imposed by EU member states, putting it at risk of a tougher commercial environment and eroding the strategic benefit for investors of locating intermediate holding companies in the UK. The UK will be free, in turn, to amend its direct tax legislation to create a more competitive environment. But substantial divergence from the EU system might make the UK less attractive to inward investors and reduce its leverage in negotiations with the EU, so is unlikely to happen.
There are proposals within the EU to consolidate corporate taxes further, in particular a proposed Anti-Tax Avoidance Directive was agreed on 21 June 2016 and there is still potential for a consolidated corporate tax base. The UK is generally against such further integration, so leaving the EU will have a potential benefit in this respect. The reality is, however, that most UK groups either have substantial interests in other EU member states or trade with such states. EU measures will therefore continue to have relevance after a Brexit.
Practical steps and contingency planning
Multinational companies should review their international strategies to determine whether, and to what extent, they use UK group companies as a gateway to the EU. They can then use the remainder of the two-year Brexit notice period to devise firm contingency plans based on the emerging shape of the UK's subsequent relationship with the EU.
Panel 2: Potential positives
|Although a Brexit brings much uncertainty, there are potential positives:
The UK is a member of the G20, OECD and WTO independently from its membership of the EU. It will thus continue to be a party to double tax treaties and other agreements that have their basis in these international organisations. Indeed, a departure from the EU will give the UK more freedom over the method and pace of its implementation of the OECD's BEPS project, and other large-scale harmonising initiatives.
|EU-wide measures can make member states less competitive and create dual levels of accountability. For example, the proposed Anti-Tax Avoidance Directive, which includes a General Anti-Abuse Rule requiring member states to meet certain minimum anti-abuse requirements. The UK has objected to proposals to harmonise corporation tax rules (the Common Consolidated Corporate Tax Base) and to introduce a new investor-state dispute resolution system (the Investment Court System), which would apply to all future EU agreements including the TTIP with the US (referred to under Indirect Taxes). If investors balk at measures of this kind, the UK might be viewed as an attractive host state by virtue of no longer being subject to them.
This article is part of our Brexit series.