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Brexit: the tax consequences

 

Posted on 27 June 2016

The UK public have now spoken and voted for the UK to leave Europe. Whilst the outcome of the vote is now known, the implications and repercussions of such a decision will not be fully known for a considerable amount of time, but what we can be sure of is that the UK and Europe are entering a period of uncertainty.

A vote “out” does not mean an immediate exit from the EU. The UK still needs to take a formal route out, by way of invoking Article 50 of the Lisbon Treaty, which establishes the balance of power for “divorce” talks and lays down voting rules for deciding how to separate the UK from Europe. It sets out a path for member states to inform EU partners they are leaving and a streamlined way for the exit to be negotiate and agreed.  

Future trade terms between the UK and the EU would be settled in a separate trade agreement, which may not be concluded over the same time frame and, in reality, will take considerably longer than the two years allowed under Article 50.

This two year time limit for exit from the EU is only triggered when the British government invoke Article 50. This is fully within their control and they can’t be forced to invoke the article by other members states. This may cause the UK to delay invoking Article 50 until they have undertaken initial discussions regarding trade agreements and other important factors.

Once Article 50 is invoked the other 27 member states will meet to discuss the UK’s withdrawal. The UK will then negotiate with the EU requiring approval by 20 countries with 65% of the population of the members states to the terms of exit. If negotiations have not concluded by the end of the two years, then there needs to be unanimous agreement of all 27 member states for the negotiations to continue. If this unanimous agreement is not obtained, EU treaties cease to apply to the UK.

Tax consequences

European law affects UK tax legislation and, therefore, the decision to exit the EU will have an impact on UK taxation.

Direct taxation

Whilst corporation tax, income tax and capital gains tax are all UK taxes, UK domestic law cannot conflict with the principles of EU law. An example of this would be the changes to the UK’s group relief and controlled foreign companies rules following the result of landmark and high profile cases by Marks & Spencers and Cadbury Schweppes won in Europe.

There have also been a number of State Aid challenges as well as investigations into transfer pricing rulings granted by some Member States to multinational companies (Apple, Starbucks, McDonald's and Fiat). On leaving the EU, the UK would no longer be bound by the State Aid Rules. However, dependent on the exit terms (for example if the UK joins the European Economic Area), State Aid legislation will continue to apply, which would be relevant in a number of areas including EIS, EMI and R&D reliefs.

The EU has a number of directives in place aimed at reducing tax burdens within the single market, notably withholding taxes.

The Parent/ Subsidiary Directive allows dividends to be paid by European subsidiaries to their EU parents free of withholding tax, and the Interest & Royalties Directive eliminates withholding taxes on interest and royalties.

Whilst the UK does have an extensive network of double tax agreements to fall back on, not all of these eliminate withholding taxes on payments of dividends, interest and royalties between the taxpayers in the UK and EU Member States – some only reduce the rate of withholding tax that needs to be applied.

In the UK, in the absence of a suitable treaty or EU Directive, payments of interest and royalties from the UK would be subject to withholding tax at 20%, meaning that the recipients may look for compensation through ‘grossing up’ clauses in legal agreements. 

As far as dividends are concerned, UK corporate recipients of dividends are normally exempt from corporation tax, so any withholding tax suffered would be an absolute cost. Conversely, on the payment of dividends by UK corporates, as the UK does not charge withholding tax on dividends, this should not be an issue for EU recipients.

The EU Merger Directive facilitates cross border reorganisations within the EU by allowing exit taxes to be deferred. Again, this Directive would no longer apply.

The guidelines for the OECD Base Erosion and Profit Shifting (“BEPS”) project were agreed in October 2015. Whilst this is guidance, it is anticipated that the UK will continue with the principles post an exit from the EU.

Personal tax

UK individuals who own assets in other EU states could find that they are no longer protected from tax and social charges that are imposed on non-EU/EEA nationals by some EU countries (e.g. Capital gains tax in France which can be as high as 49%). Although the tax rate being applied may increase, providing there is a valid double tax treaty in place, UK individuals should be prevented from paying tax twice,

UK workers in Europe are only required to pay social security contributions in one Member State. With the UK leaving the EU, this may increase the social security costs for the employer and company.

Value Added Tax

The UK legislation governing Value Added Tax (VAT), as well as customs and excise duties, has to conform with principles established by EU law, which means that currently both the EU law and the CJEU case law are the main sources of UK indirect tax legislation. 

On an exit from the EU, the UK would no longer be bound by European constraints, for example, which goods and services can be exempt or zero rated for VAT purposes and the rate at which VAT is charged. This could provide the UK government with a greater degree of flexibility from a UK indirect tax perspective.

In addition the UK taxpayers would be no longer bound by decisions of the CJEU. This however would be only likely to be relevant for future cases as historic decisions have in the main already been adopted into UK legislation or HMRC policy.

Goods can be supplied freely within the EU (and European Economic Area) without the imposition of customs duties. Unless the UK successfully negotiates a trade agreement with the EU, exports and imports of goods between the UK and the EU could be hit by customs duties and import VAT, thereby increasing the cost of the goods. To further complicate the situation, the EU have historically negotiated favourable trading terms with many other countries – if the UK leave the EU such terms would need to be renegotiated.

Businesses with international supply chains will need to re-assess their supply chains, taking into account possible additional duty costs and / or administration.

Service industries could also be affected. Currently businesses who are required to pay VAT in a number of Member States have the option to use a simplification scheme (MOSS) which allows them to register in one Member State and account for VAT across the EU on a single return. Clearly this would need to be addressed. In addition, businesses who have a requirement to register and pay VAT in locations where they do not have a permanent establishment could be required to appoint fiscal representatives once the UK has left the EU.

What next?

Businesses and individuals in the UK and the wider EU are entering a period of uncertainty as discussions and negotiations progress. Once Article 50 is activated this provides at least two years for our exit to be agreed and as such, there is no need for decisions to be made immediately. However, we recommend that consideration is given to the potential outcome of the negotiations when undertaking business planning and establishing funding requirements.

Please contact us should you wish to discuss how Brexit impacts you and your business. 

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