As we await the outcome of discussions between the UK and EU member states our specialists have analysed the potential ramifications of a departure from the EU, depending upon whether or not Theresa May and the Government reach any agreement with the EU.
This is not a comprehensive overview but highlights some of the potential changes that could affect the UK’s tax system. Some possible practical tax implications are also noted, though this is not intended to be a full note of all possible tax implications.
|Supremacy of EU/EEA law over UK law
EU law takes precedence over UK law. Any UK law which introduces EU law must be interpreted in the light of the wording of EU law.
There is recourse to EU Courts (CJEU) to challenge the application of national law by other member states.
EEA agreement only provides for a system that promotes the implementation of EU law into EEA law. While there is no direct permission to rely on EEA law when national law conflicts with it, EEA members are obliged to consider EEA law (whether implemented in national law or not) when interpreting national law. However the UK could still be liable if it had not fully implemented EEA law.
Recourse would be available to the EFTA Court to challenge the application of national law by other EEA member states.
The UK would not be subject to the constraints of EU/EEA law, though such law may be taken into account. EU law would probably still be relevant for disputes relating to periods prior to the UK’s exit.
There would be no recourse to EU/EFTA courts should the UK find that other EEA country rules had an adverse impact on the UK in an unfair manner.
Impact of EU/EEA law on direct tax
Four fundamental freedoms have influence on direct tax: free movement of goods, services, persons and capital. Most relevant provisions are:
Freedom of establishment, free movement of capital, non-discrimination and restriction on state aid.
Similar principles to those applicable for EU law apply to EEA law.
There would be no requirement to comply with EU law. However the UK would probably be required to comply with World Trade Organisation rules (see below).
There may be some scope for the UK to widen its tax incentives to SMEs without the constraints imposed by State Aid rules.
Seeks to ensure cross border intra-EU company reorganisations within scope are tax neutral. Company needs to have:
There are other requirements. Exit taxes are not prohibited by the mergers directive, but a choice of immediate or deferred payment must be offered.
It may be possible for the UK to achieve the advantages of the merger directive as a member of the EEA (or EFTA) provided the other state has tax neutral re-organisation provisions for purely domestic exchanges of shares, and that this does not give rise to taxation of unrealised capital gains and tax-free reserves.
Regarding exit taxes, it is likely that a choice of immediate or deferred payment would be required to be offered to comply with the EEA agreement, subject to the local law of the relevant jurisdiction.
The EU/EEA requirements of the mergers directive and principles on exit taxes would no longer be mandatory.
The UK may wish to keep some or all of these principles in effect to continue to make location in the UK attractive to business, though application is likely to depend on double tax treaties.
Where conditions are met, the directive eliminates withholding taxes on cross border intra-EU interest and royalty transactions
All cross border intra EEA payments of interest & royalties would be outside the scope of the directive, and would not be protected by fundamental freedoms of the EEA agreement.
Obligations on withholding tax would depend on double tax treaties.
The interest and royalties directive would not apply.
Obligations on withholding tax would depend on double tax treaties.
In the absence of specific post-Brexit arrangements, any EU Member State could reintroduce withholding tax for interest payments by its own resident companies to group companies resident in the UK. In such case, the only way for the UK to maintain (from the viewpoint of group companies) the attractiveness of exclusive taxation would be to grant a unilateral exemption for incoming foreign interest payments.
Where conditions are met, this prevents EU member states charging indirect tax on companies raising capital.
As a result of this directive HMRC no longer seeks to impose the 1.5% SDRT on issues of shares and securities to depository receipt issuers and clearance services in certain circumstances.
The capital duties directive would not apply.
Subject to complying with the principle of freedom of movement of capital the UK could re-impose the 1.5% SDRT that it currently does not impose.
The capital duties directive would not apply.
Subject to complying with WTO principles the UK could re-impose the 1.5% SDRT that it currently does not impose.
Social security agreements
The EU is a signatory to the EU social security agreements which means workers who move within the EU are only subject to social security of one member country.
EU social security agreements apply to EEA member states.
Other non-EU countries have signed the EU social security agreement as a non-member (Switzerland has done this), so the UK may wish to apply for this should it leave the EU altogether.
1.1 A bilateral treaty with the EU
A fourth scenario, not covered above, is the possibility of the UK negotiating a bilateral treaty with the EU in a similar fashion to those negotiated by Canada and Switzerland. However the tax issues from such a bilateral treaty would depend on the terms of the treaty. The examples of Canada and Switzerland appear to indicate that EU rules would need to be adopted in exchange for market access, so that tax issues in relation to areas covered by such a treaty might be similar in some ways to the position of an EEA country.
1.2 World Trade Organisation (WTO) rules
Summary of WTO rules that could apply to influence how the UK applies tax measures were it to leave the EU/EEA:
- GATT (general agreement on tariffs and trade):
- most favoured nation (MFN) treatment – so that there is no discrimination between trading partners’ goods; and
- national treatment (NT) so that domestic taxes and charges should not be applied so as to afford protection to domestic production.
- TRIMs (trade related investment measures applies to trade in goods only) – prohibits WTO members from applying any TRIM that is inconsistent with NT and the general elimination of quantitative restrictions of GATT
- Agreement on subsidies and countervailing measures divides (SCM) subsidies into prohibited and permissible subsidies
- GATS – general agreement on trade in services – embodies the principles of MFN and NT for services
- TPRM – trade policy review mechanism is a system promoting transparency to help ensure countries apply the other aspects of WTO rules.
Application of these WTO rules in relation to tax may be affected by double tax agreements and whether tax systems of the UK or other jurisdictions are capital export neutral or capital import neutral.
1.3 Practical implications – direct tax
- Cross border re-organisations: Some businesses may seek to relocate certain business operations to or from the UK. Any such reorganisations might increase the tax risks faced by a business as a result of the focus on BEPS resulting in possible increased complexity to the practical application of a reorganisation. Certain tax free or tax deferred arrangements currently available for business reorganisations within the EU may disappear.
- Cross border activities: The UK might be treated as a ‘third country’ from an EU perspective, with consequent implications for businesses currently benefiting from the freedom of establishment rules as applied to arrangements set up cross border within the EU.
- Withholding tax issues: Although the UK has a comprehensive network of double tax treaties, not all provide for zero withholding tax as currently applies on cross border intra EU interest and royalty payments as a result of the EU parent subsidiary directive.
- Renegotiation of social security arrangements with EU countries: Currently employees moving within the EU are only subject to social security contributions from one of those countries. This arrangement would need to be renegotiated with the EU to reinstate this practice.
- Potential freedom from EU state rules: There may be freedom from restrictions currently imposed by EU state aid rules to tax incentives for certain business sectors. However, any ability to diverge from current practices would probably be influenced by the type of trading and customs duty/tariff agreements the UK might have with the EU.
2. Indirect tax issues (value added tax - VAT)
The UK would almost certainly retain its VAT system in some form: the UK collected £111bn from VAT in 2014/15, around 23% of total revenues.
However, the VAT regime is currently strictly governed by EU directives (as explained above), and the UK will be both required and free to make changes to its VAT regime in the future. Changes will be needed to address the fact that, in the near future, the UK will no longer be an EU member. For example, by definition ‘intra-community supplies’ will simply no longer exist for the UK. On the other hand, the UK will be free to set its own rules. Realistically, this freedom will be restricted by practical considerations and international agreements other than EU rules, but potential domestic changes would include the applicable VAT rates and exemptions.
As we are expecting a negotiation period of at least two years before Brexit can be completed, immediate changes to the UK VAT regime are unlikely. However, there will no doubt be many proposals, opinions and much speculation and we will produce regular updates to support your business and help you prepare for these changes.
2.1 Practical implications of any change – indirect tax
MOSS: The availability and operation of MOSS (mini-one stop shop) for UK businesses operating in Europe and European businesses operating in the UK may change.
Potential additional burdens: If the UK is regarded as a third country as a result of being outside the EU, some EU countries may require UK businesses operating in the EU to appoint a fiscal agent as a requirement for complying with local VAT rules. Other features of the VAT regime, such as the tour operators’ margin scheme, are likely to change.
Input tax recovery: There may need to be changes to the UK rules on whether input VAT is recoverable on exempt services provided to customers located outside the UK.
3. Customs duty
Customs duty is an EU tax imposed by EU regulations. Customs duty is charged on the import of all goods into the customs territory of the EC when those goods are released for free circulation. It is charged on import and collected by the Member State into which the goods are imported. In the UK customs receipts currently amount to around £3bn annually, around 0.6% of total revenues.
EFTA states are not part of the EU customs union, additional duties and tariffs may be applied by EFTA countries for goods imported from outside their borders. EU countries are not permitted to set their own customs tariffs - this must be done only by EU-wide agreement. www.conformance.co.uk/info/eea.php
However EFTA members are required to comply with the principle of freedom of movement of goods. www.efta.int/media/publications/fact-sheets/EEA-factsheets/GoodsFactSheet.pdf
On leaving, EU customs duty would no longer apply. This would mean that the UK would lose revenue from collection of EU customs duty. Customs duties would be charged on the export of goods from the UK to the EU.
However, the UK would no doubt enter into some form of agreement with the EU (and if necessary the EEA) on customs duties. In any case it would no doubt be bound by WTO rules. Thus in practice Brexit may make little difference for customs duties, other than require changes to compliance procedures.
3.1 Practical implications of change – Customs duty
- Administrative changes: If the UK left the Customs Union there could be change in paperwork and systems to cope with the UK’s new status outside the Union. However some countries currently outside the EU, such as Turkey and Andorra, are members of the Customs Union.
- Changes in duties and tariffs: If the UK left the EU, changes in customs duties and tariffs may apply for both outbound and inbound goods.
- Additional requirements: If the UK is not part of the Customs Union, then there may be added requirements for applying rules of origin to access tariff free trade with the EU.
- Supply chains: The practical aspects of putting in place systems and procedures to clear movements to and from the EU may initially result in bottlenecks in supply chains. It may be appropriate to consider strategies for managing stock levels and supply chains in preparation for the transitional period.
EU – European Union: an economic and political union between 28 countries who are Austria, Belgium, Bulgaria, Croatia, Republic of Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the UK.
EEA – European Economic Area: the EEA is an Internal Market governed by the same basic rules and is made up of the 28 EU countries and Iceland, Liechtenstein and Norway.
EFTA – European Free Trade Association: an intergovernmental organisation set up for the promotion of free trade and economic integration to the benefit of its four Member States: Iceland, Liechtenstein, Norway, and Switzerland. While Switzerland is neither an EU nor EEA member it can access the single market - so Swiss nationals have the same rights to live and work in the UK as other EEA nationals.
CJEU – The Court of Justice of the European Union.
TFEU – Consolidated treaty on the functioning of the EU.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.