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Following the United Kingdom's decision to leave the European Union as a result of last month's referendum on the issue, this article looks at the possible tax consequences of a "Brexit."
EU member states are still largely free to set their own tax systems. However, there could be consequences for a number of UK taxes as a result of Brexit.
Value-added tax (VAT) is the only tax that is harmonized (at least in part) under the EU VAT directive. Thus, Brexit would have clear ramifications for UK VAT.
EU laws and principles also restrain member states in other ways with regards taxation. Each country must ensure that its tax rules do not distort the single market and discriminate between resident and non-resident taxpayers within the EU. State aid rules also prevent governments from offering tax incentives and other forms of state support to certain companies, economic sectors and geographical areas. Therefore, in theory, Brexit would give the UK Government more freedom over its tax system.
However, at the same time, the UK could be constrained by economic factors. It is widely expected that the economy will suffer to some extent as a result of the vote to withdraw from the EU, and this will have implications for fiscal policy. As many economists warned prior the referendum, Brexit would probably lead to tax increases and public spending cuts.
For taxpayers then, Brexit could be both a blessing, and a curse.
The EU VAT directive stipulates that member states must charge a standard rate of at least 15 percent, and limits the goods and services to which reduced and lower rates may apply. This would no longer be the case if the VAT directive ceased to have legal force in the UK. What's more, the UK would probably no longer be bound by rulings of the European courts in the area of VAT. However, the UK Government's greater freedom over VAT could be a blessing in disguise, as Richard Asquith, Vice President of Global Indirect Tax at Avalara Inc observes.
"Following the conclusion of exit negotiations, which will likely take two years, the UK will leave the EU VAT regime meaning that UK businesses will be no longer be obliged to follow the EU VAT Directive. This will create many new VAT compliance obligations and complexities, particularly for companies selling from and into the UK. Companies will require heavy investment and planning to cope with the change."
"We could see some businesses benefit with potential reversals on EU rulings, such as the UK's proposal to offer reduced VAT on solar panels which was originally rejected. British tourists are also likely to be better off with them now eligible to claim VAT refunds for EU goods brought back into the UK. However, whilst these are both positive, the UK will now have to pay various non-tariff 'frontier costs' of bringing goods into the EU's single market which could add EUR3.6bn (USD4bn) to the cost of exporting into the 27 EU states. This won't take place immediately but UK exporters need to get the groundwork underway to understand what this means for their financial processes and systems."
Adam Craggs, Partner and Head of the Tax Dispute Resolution team at City law firm RPC, suggests that there could also be implications for the imposition of VAT on cross-border supplies involving the UK. "'Import' VAT could be imposed when goods enter the EU from the UK and vice versa, which could lead to an unwelcome cash flow cost for businesses for the period between import and recovery," he warns.
He continues: "It is likely there will have to be technical changes in relation to, for instance, methods of reclaiming VAT from EU tax authorities (for example, the VAT incurred by businesses in member states of the EU). One issue which is likely to arise is the extent to which existing VAT case law (pre-Brexit) remains applicable in the UK."
"In addition, many EU Directives and other forms of law have corresponding UK laws that implement them. It is unclear which of these laws will remain following our exit from the EU."
Given the potential for double taxation and increased uncertainty, Craggs concludes that the UK Government may decide to leave the UK VAT regime substantially aligned with the EU VAT directive.
The UK currently has one of the most competitive corporate tax regimes in the EU, with its already relatively low 20 percent rate of corporation tax set to fall to 17 percent by 2020 under current law. This is likely to remain the case post-Brexit, as the EU has limited say over how a member state can set up its corporate tax regime. The UK will, however, see restrictions lifted in certain areas.
Depending on the sort of new relationship the UK negotiates with the EU, Britain may no longer be bound by the state aid rules. State aid is defined by the European Commission as an advantage in any form whatsoever conferred on a selective basis to undertakings by national public authorities. The European Treaty generally prohibits state aid unless it is justified by reasons of general economic development because it tends to distort competition in the Single Market and affect trade between member states.
Potentially, this allows the UK to offer tax incentives to a much wider range of taxpayers. It could also encourage future governments to establish special economic zones with special tax regimes in economically-depressed areas, although there are no indications that this is on the cards.
"In the longer term, if the UK does not join either the European Economic Area or the European Free Trade Association, it will have complete control over the setting of taxes within the framework of existing double tax treaties. This will mean that the government will no longer need to seek European approval in respect of state aid or tax incentives such as enhanced capital allowances," noted Brian Palmer, Tax Policy Adviser for the Association of Accounting Technicians.
Again, there is the question of how past state aid rulings, which may have resulted in changes to tax legislation, will be treated in the UK.
And what about EU initiatives currently in the pipeline? Presumably, the UK would not have to adopt the latest anti-avoidance package, and would be excused from participating in corporate tax harmonization projects should they be approved at EU level, notably the proposed common consolidated corporate tax base.
Palmer also said that Brexit may influence the UK's participation in the OECD's base erosion and profit shifting (BEPS) project. He observed that "up until now it has been an early adopter, but this might no longer be the case, which could hurt attempts to combat companies shifting profits to low and no-tax locations."
The signals coming out of the previous Cameron-led Government suggested that the UK would seek to make its corporate tax regime more competitive as a result of Brexit, to ensure that the UK remains attractive to foreign investors. To this end, former Chancellor George Osborne said that he was considering cutting corporate tax to 15 percent or lower. Where corporate tax policy is headed under the new leadership of Prime Minister Theresa May is not so clear. Phillip Hammond, Osborne's successor, has said there will be no emergency Brexit budget, and this indicates that the Government values stability over change in a period already subject to much turmoil.
An important consideration for multinational groups is the Parent/Subsidiary and Interest and Royalties directives. These laws, both transposed into UK legislation, are designed to ensure that intra-EU dividend distributions and payments of interest and royalties between certain companies of the same group are not doubly-taxed and are therefore significant to groups trading within the EU. While such taxes could be mitigated under a double tax treaty (DTT) – and the UK has one of the world's largest networks of DTTs – there are likely to be more unfavorable withholding tax outcomes on intra-group payments in the EU than there are at present.
Many of the tax outcomes of Brexit will flow from the type of trade deal that the UK manages to secure with the EU, which will dictate to what extent EU rules will continue to apply in Britain. There are a number of possibilities in this area, from remaining in the EEA along with Iceland, Liechtenstein, and Norway – in which case the UK would stay in the single market, but be bound by EU legal principles such as state aid and freedom of movement – to something resembling the "Swiss model" – sectoral deals giving the UK more limited access to the single market with fewer strings attached.
The UK could of course simply sever all ties with the EU, and this remains a possibility if no settlement can be reached within the prescribed time limit. Under this scenario, the UK would obviously lose access to the single market and the EEA, meaning that businesses in the UK would not only face many regulatory hurdles when trading with the EU, but also have to pay trade tariffs.
Leave campaigners argued that Brexit would allow the UK to pursue trade deals with key economies not currently included in free trade agreements negotiated by the EU. And there have been some encouraging signs from across the Atlantic, where House of Representatives Speaker Paul Ryan (R – Wisconsin) has called on the US Administration to pursue an FTA with the UK. A bill has also been introduced into the Senate with the same purpose.
However, as far as the President Barack Obama Administration is concerned, a UK FTA probably remains a low priority, with the Transatlantic Trade and Investment Partnership talks in mid-stream. Or, as President Obama himself put it, the UK is at the "back of the queue" for an FTA.
Another problem is that bilateral and multilateral trade agreements are complex instruments, requiring much time and effort to conclude. It is by no means guaranteed that the UK could quickly build up a network of FTAs, given most of its focus for short- to medium-term will be on arranging its divorce with the EU.
It must be stressed that the referendum was only advisory in nature, and has no legal force on the Government. It is uncertain whether the referendum result would have to be endorsed by a parliamentary vote in favour of Brexit, and elements of the pro-remain camp are challenging the authority of the Government to proceed with Brexit negotiations on the strength of a narrow referendum result. Nevertheless, new Prime Minister Theresa May – herself a former Remainder – has said the Government respects the decision of the voters, and will resolve to negotiate a Brexit. It must therefore be assumed that the UK will, at some point, have a different legal and trading relationship with the EU.
However, for this to begin, the UK must trigger Article 50 of the Lisbon Treaty, and May has indicated that this won't happen until next year. Once it does, there will be a two-year time limit for a withdrawal agreement to be reached, unless the remaining 27 member states vote unanimously to extend this deadline. In the meantime, the UK remains a full member of the EU, with all its rights and obligations intact.
Tags: tax | Europe | Tax | law | trade | business | tax incentives | BEPS | agreements | legislation | European Commission | corporation tax | withholding tax | Iceland | Liechtenstein | Norway | United Kingdom | investment | interest | royalties | fiscal policy
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