Now that negotiations have been commenced it is, perhaps, time to look at the path along which the UK is heading towards leaving the European Union.
The Political Position
After the result of the referendum was announced there seemed to be a period of silence. However, after a new Prime Minister came in, we had something called the Great Repeal Bill published on 10th October 2016. This is a little bit of a strange bill, because it could easily be argued that it is the Great Enactment Bill. The purpose of the Great Repeal Bill is to remove the European Communities Act 1972 from UK law and convert all EU law which exists at the time the UK leaves the European Union into domestic law. So the simplistic way the UK initially will deal with EU law is to make it UK law. I am not sure the majority of those who voted realised that was going to be the case.
Subsequently, on 17th January 2017, the Government published a White Paper which set out 12 negotiating principles to be applied when negotiating our exit terms. Article 50 was exercised in March 2017 and then we had the rather strange calling of a General Election. Despite the Conservative party losing their overall majority they remain in power and now negotiations have finally commenced.
So what are we leaving? Well, in terms of tax, the EU laws which are relevant are those relating to leaving the customs union or single market (the harmonised VAT system), corporate tax (which, although not harmonised, is the subject of proposals in place to do so), various directives (such as the Parent Subsidiary Directive, the Mergers Directive, and the Interest and Royalties Directive), together with the measures relating to the European Court of Justice, freedom of establishment and movement, etc. The UK view is that the EU restrictions on things like State Aid, discrimination, European-controlled foreign companies, transfer pricing and transfer of assets should not apply to the UK, and the UK will not be affected by things that are still to come like the consolidated corporate tax base and the Anti-Tax Avoidance Directive.
What is going to happen? What is Brexit? The answer given by the Prime Minister was that Brexit means Brexit and that is it. In terms of what that means in a little bit more detail, it could mean a number of things. We could have a Brexit in the form of leaving the EU and entering into a European economic area or a free trade area, similar to the Norwegian model, or maybe a European free trade agreement with bilateral agreements similar perhaps to the Swiss model. There could be a free trade agreement without free movement, which I think Ukraine has, or a bespoke free trade agreement similar to the Canadian model. The UK could also become part of the customs union without a free trade agreement, which is similar to the arrangements with Turkey and the arrangements the World Trade Organisation rules provide for. If the UK goes along the lines of, say, membership of a European economic area then that is probably the preferred alternative from the EU’s perspective. However, from the UK’s perspective, that would not be politically attractive because it retains free movement of people, effectively retains sovereignty of the European Court, budget contributions would still have to be paid and around 75% of European legislation would still be applied to the UK with no influence over how that legislation is enacted. There would also be additional bureaucracy as a result of complying with rules of origin. At the present time 23% of the value of goods exported from the UK is derived from foreign components and so importation and subsequent exportation procedures would need to be applied.
Suppose we went down the route of membership of a customs union similar to the Turkey model which I believe is the only example of a non EU state being a member of the European Customs Union. This applies to most goods but there are some exceptions. It is not a regulatory union so there are still barriers to trade and no vote in the EU in terms of free trade negotiations. Turkey must, however, provide tariff-free access for any negotiated free trade arrangements. There is also no sharing of customs revenue so the ability to have an independent external trade policy is very limited. So, this is not particularly attractive either. There could in theory be a bespoke free trade agreement, with lower tariffs than usual under the World Trade Organisation. This would provide for no customs union, no onerous rules of origin requirements and cover services as well as goods. The problem with this solution for the UK, unlike, say, Canada is that the EU is unlikely to grant significant market access without compliance with EU law. EU agreements show that it is possible to have access to the single market without freedom of movement of people. However, although it may not be clear at the moment, I think the way that the EU are positioning themselves makes it extremely unlikely that they are going to give any allowances on a bespoke free trade agreement unless the UK allows free movement of people.
Relying on the World Trade Organisation seems to be favoured at the moment by the hard-core Brexiteers. Their view is “do we really need a deal? After leaving the EU we can trade under World Trade Organisation rules.” If the UK does that it will need to negotiate or develop its own individual World Trade Organisation schedules. The UK could then negotiate with the EU, subject to non-tariff barriers, with the application of quotas. In addition, the most-favoured nation provisions would mean that the EU cannot impose tariffs on the UK in excess of those on other countries. The stumbling block, however, is that generally there is no preferential access to the single market.
Looking at the government White Paper which set out the 12 principles for negotiation, immigration is the big issue for the UK voting public. Another is strengthening the union of the UK countries, which is quite interesting when one of the things that seems to be happening is that the Scottish are even more keen, or some of their political parties are even more keen, on trying to get out of the union. It remains to be seen how negotiations will deal with the Irish situation. A lot of people forget that the UK has a land border with the EU, between Northern Ireland and the Republic of Ireland.
Looking at customs duty the UK position at the present time is that it intends to seek trade agreements with countries outside the EU and look for a reciprocal tariff free trade agreement with the EU. The government accepts that being out of the EU, but a member of the European Economic Area, would mean complying with the EU’s rules and regulations, without having a vote on what those rules and regulations are. Being a European Economic Area member would mean accepting a role for the European Court of Justice. It would also mean not having control over immigration. The conclusion, therefore, is that the UK does not see being part of the European Economic Area as an option. In addition the government has said that, rather than full customs union membership, they will seek a new customs arrangement. The government’s guiding objectives for a future customs arrangement are to ensure that trade continues to be as frictionless as possible, whilst being able to negotiate the UK’s own preferential trade agreements around the world. So it seems from that statement from the government that the UK would like a tariff-free trade agreement with the EU and an ability to negotiate our own agreements with other countries around the world.
Moving now onto some of the more detailed aspects of what may or may not happen, the first one to touch on is VAT. This is the most obvious tax that may change significantly as it is based on EU law. VAT gives rise to the second highest percentage of tax collected, 22% for the 2015/16 fiscal year. VAT rules are already fully implemented in UK law, so they are not automatically going to fall away when the UK leaves the EU. The UK wants to negotiate a free trade agreement with the EU that is based on common trading rules, and there is little in the way of political need or desire to change the VAT rules. UK businesses dealing with the EU will still be subject to EU VAT anyway so, to have something radically different from EU rules, may seem a little odd. Consequently, I do not see a great deal changing in terms of UK VAT.
There will, nevertheless, be some consequences of leaving the EU for UK VAT rules. For example, the rules determining the place of supply are likely to change. If you are a VAT practitioner, or handle VAT, one of the big changes that might affect even non-EU people is registration. A business supplying electronic services may have taken advantage of what is known as the “mini one-stop shop” to date, whereby a business registers for VAT in one EU country and then charges VAT across Europe. Any businesses registered in the UK under that system will, once the UK leaves the EU, need to find another EU country in which to register.
The same will apply to UK companies which are providing electronic services; as the UK will be outside the EU, they will need to register in another EU country.
Another area that will provide some difficulty is what is known as triangulation. At the present time, if a UK company buys goods from Germany and sells them to a customer in Italy, it can take advantage of a reduced accounting procedure known as triangulation. This effectively means that the transaction is treated as if the goods pass straight from Germany to Italy. The UK company, if it plays no other part in the transaction, will then put a declaration on their invoice and does not have to account for VAT. Once the UK is outside of the EU, then, like any other business outside the EU, a UK company buying or selling goods within the EU may have an obligation to register, in this case, in Germany or Italy or even both countries.
Other potential challenges are that, once outside the EU, there is the possibility of maintaining or tinkering around with some of the rules. There may also be a temptation to change some of the laws where the UK has lost a case in the EU courts.
Let us now look at some direct taxes. If leaving the EU means an end to the EU Directives, how would that affect the UK holding company regime? The UK does not need to rely on EU Directives to avoid withholding tax. For example, the Interest and Royalty Directive prevents withholding on interest and royalties between companies in the same group, and the Parent Subsidiary Directive prevents withholding taxes on dividends. Looking at the position post-Brexit from a UK point of view, for inward investment into the UK, the Directives are not generally that important. The UK has no withholding tax on dividends and no capital gains tax on disposal of shares by a non-resident without a UK permanent establishment. Interest withholding tax is at 20% but a lot of people/companies use treaties, discounted notes or Eurobond lending to get around that. Royalty withholding tax is, again, 20% but typically that can be avoided through treaties with the main trading countries.
More interesting perhaps is the position of UK taxpayers suffering foreign withholding tax. Interest and royalties are often exempt from withholding tax between EU entities under UK treaties but there are numerous exceptions. The main countries that would be affected are Germany and Italy, which would both apply withholding tax. The solution may be to interpose a company in another EU jurisdiction to make use of the Parent Subsidiary Directive within the EU with the payment to the UK from a country which does not impose withholding tax. This is something, however, that the Multilateral Instrument recently signed by a number of countries may address.
There are other EU Directives (Mutual Assistance, Administrative Co-operation) on which Brexit is unlikely to have a material effect given that the obligations are already imposed in the UK under primary law. There is also a lack of political will to stop international co-operation and common reporting standards and treaty obligations will still apply. Mutual assistance and administrative co-operation will, therefore, probably not change. As for the Mergers Directive, the tax rules it contains are already present in UK primary legislation so that should not be affected.
The Transfer Pricing Arbitration Convention and Capital Duty Directives, however, will cease to apply without any current UK law. It will therefore be necessary to look to reliefs with tax treaties in the future.
UK subsidiaries could potentially be subject to EU controlled foreign company rules. Over the next couple of years the UK corporation tax rate is being reduced to 17% and there has also been talk, although it has been blocked at present, of reducing the rate to 15%. There has also been some suggestion of the UK becoming a tax haven if a good deal is not obtained but I think that is probably just grandstanding. I cannot see the UK positioning itself as a tax haven as this would damage trade with the EU and, ultimately, may result in the UK being blacklisted by the EU. The UK may, however, reinstate rules held to be contrary to EU law. The two main candidates are the decisions of the ECJ in Cadbury Schweppes, which I think unlikely to be changed, and Marks & Spencer where the UK might bring back restrictions on the ability overseas losses against UK profits.
The EU actively challenges laws of Member States if they are seen to be discriminatory, to breach fundamental freedoms or constitute State Aid. This would no longer be applicable or relevant when the UK leaves but I believe proposals such as BEPS are likely to remain.
The Anti-Tax Avoidance Directive and the Consolidated Corporate Tax Directive are scheduled to come into effect on 1st January 2019. So, assuming that the UK leaves the EU in two years’ time, there is potentially a period of around three months during which these new directives would be in force. In practice it is unlikely that these will ever be brought into UK law, particularly the Consolidated Corporation Tax Directive, as the UK has opposed them to date.
So, to sum up, the UK holding company regime is unlikely to change dramatically. The main areas that will require attention or restructuring are where UK companies are part of EU groups. Maybe rearranging some of those groups in order to make use of treaty reliefs and ensuring the demise of the Parent Subsidiary Directive does not give rise to withholding taxes would be wise.
Individual taxes are very unlikely to be affected. The non-domicile remittance basis will remain subject to the new rules which were originally to come into effect from 6th April 2017. These are of far greater concern to individual taxpayers than the Brexit positon. Capital tax treaties would be unaffected so not a lot of change for individual taxes.
Brexit has some positives for the UK. It gives independence from the EU. It will give the UK some scope for implementing its own laws. Tax treaties and other agreements will remain in effect. It gives the UK freedom over the implementation of international measures, such as BEPs, rather than following the EU rules. It avoids the consolidated tax base. The Anti-Tax Avoidance Directive will not apply within the UK although the UK has a domestic general anti-avoidance rule. The UK will not be required to adopt the consolidated corporate tax base and tax sovereignty will be maintained, which the UK sees as important.
There are some negatives relating to access to European markets. The UK position seems to be that we do not want to be part of the European Economic Area, but we do want a free trade agreement with Europe. How that will be implemented in practice remains to be seen.
I think the EU will impose a number of restrictions on the UK. The EU Commission has stated that the UK will not get a better deal than anyone inside the EU so there will certainly be some reduction in benefits. The UK may see additional taxes on imports, without a free trade agreement, and there may be customs duties on imports, which would potentially make goods in the UK more expensive.
I think there is going to be some free trade agreement or some link with the EU but this will come at a cost. That cost is likely to result in the UK giving up some rights or accepting some EU policies into UK law. However, once outside the EU, the UK will have no influence on EU policy.
Once outside the EU there will be a loss of protection from discriminatory EU measures. The EU has principles of freedom of establishment, freedom of movement, freedom of capital which may work against the UK in the future. There will be nothing to stop an EU business discriminating against a UK business and the protection of the EU Courts will no longer be available.
However the negotiations proceed and whatever final deal is agreed there is going to be a tougher commercial environment for the UK. At this time the only certainty is uncertainty which is not good for business or for tax practitioners