Parting is painful: Brexit and its tax and legal implications
Article published in "Der Betrieb"; DB dated 08.07.2016, no. 26-27, page 1526 - 1530, DB1208809 in German language
Dr. Oliver Busch, Dietmar Gegusch, Dr. Alexander Linn, Bettina Mertgen, Dr. Fariba Peykan, Deloitte GmbH Wirtschaftsprüfungsgesellschaft; Klaus Gresbrand, Dr. Mathias Hanten, Dr. Söntje Julia Hilberg, Dr. Julia Sierig, Dr. Florian-Alexander Wesche, Stefan Wilke, Deloitte Legal Rechtsanwaltsgesellschaft mbH.
Divorces are often expensive and protracted affairs. That is also likely to be the case with the break-up of the not always harmonious union between the United Kingdom and the EU. The relationship following the break-up, the exit of the United Kingdom from the EU, is expected to be fraught with much bitter wrangling. Companies having business ties with the United Kingdom will be directly affected by the expected changes in the tax and legal framework conditions. It will be shown in the following what tax and legal consequences will now have to be faced particularly by German companies.
On 23 June 2016, a majority of voters – albeit a narrow one – in the United Kingdom (United Kingdom of Great Britain and Northern Ireland, referred to here as Great Britain for the sake of simplicity) decided for an exit of Great Britain from the EU (Brexit). Following the referendum, a case of voter’s remorse has been observed amongst some Brexit advocates, but the path to exiting the EU can hardly be stopped now. Prior to the exit, negotiations on the terms and shape of future relations between the EU and Great Britain will take place. Already now, depending on the various exit scenarios, potential tax and legal consequences are emerging for which preparations should be made at an early stage.
II. Procedure up to the exit
For official exit negotiations on an exit to begin, Article 50(3) TEU requires that the intention of Great Britain to withdraw from the EU be submitted to the European Council. Before such exit intention is declared, however, a resolution of the British parliament must be adopted which must involve both houses and be executed by the Queen. For the exit negotiations, Article 50(3) TEU provides for a two-year time period. This time period commences upon notification of the exit intention to the Council and may be extended only unanimously by the Council by mutual consent with Great Britain. In the event that Great Britain and the Council should not have reached any exit agreement by the expiry of this time period, EU membership ends automatically. Otherwise it ends subject to entry into force of the exit agreement. The European Council is preparing itself for the negotiations on the agreement without the participation of Great Britain in the Council by defining guidelines on a consensual basis. No substantive criteria are defined in the TEU when it comes to the drafting of the guidelines and the agreement. The exit agreement itself is adopted by a qualified majority in the Council after approval by the European Parliament (4th sentence of Article 50(2) TEU). Since it is a bilateral agreement between the EU and Great Britain, ratification is required only in Great Britain. But even after exit from the EU has been concluded, the door remains open for re-entry. That said, there is no “re-entry bonus” for this and the “normal” accession procedure must be completed (Article 50(5) TEU).
III. Existence of treaties under public international law and national legislation
Although exit from the EU will mean that European primary and secondary legislation will no longer apply and that, as a consequence, neither decisions of the European courts will be taken into consideration nor national regulations will be interpreted in compliance with EU law, EU legislation as transposed into national law (e.g. on the basis of EU directives) will initially remain in force. The British legislature would have to amend these regulations deliberately. Depending on the depth and amount of regulations, a certain legal framework adapted to EU norms will initially remain intact.
Furthermore, what are referred to as mixed agreements, i.e. treaties under public international law to which the EU along with the individual Member States are parties, will continue in force. The most important one is probably the Agreement on the European Economic Area (EEA); it will certainly be a subject of discussion in the exit negotiations. However, there are other agreements in the respective economic sectors that are of significance for economic relations with Great Britain that will continue to apply, such as the Energy Charter Treaty. It is doubtful whether Great Britain would call such agreements into question.
IV. Current need for companies to act
Until it leaves, Great Britain remains a member of the EU. Even though the decision by British voters has resulted in sharp swings on the stock and foreign currency markets, nothing will change initially. However, waiting until the exit agreement has been signed could have fatal consequences. Possible future tax and legal changes following an exit should be taken into consideration prospectively in current corporate decisions. Moreover, it is necessary, in anticipation of the changes following an exit, to plan organisational steps in the company and where possible to review and adapt existing structures also with a view to negative consequences.
It the following pages it will be shown – without any claim to completeness being made – in what areas tax and legal consequences might result from the exit of Great Britain from the EU.
V. Tax consequences
1. Income taxes
On termination of EU membership, the protection in the relationship to Great Britain conferred by the Directives in the area of direct taxes (Parent-Subsidiary Directive, Interest and Royalties Directive and Merger Directive) will cease to exist. In addition, primary law no longer applies, as a consequence of which corresponding national rules by which tax benefits were extended to the EU/EEA territory are no longer applicable.
a) Parent-Subsidiary Directive and intercorporate privilege (Schachtelprivileg) for trade tax no longer applicable
Dividends of German companies paid to a British parent company are currently subject to the prohibition on withholding tax pursuant to section 43b of the German Income Tax Act (Einkommensteuergesetz – EStG). Upon the end of EU membership, tax subjects will rely on the DTC with Great Britain that provides only for a reduction of withholding tax to 5% (Article 10(2)(a) DTC Great Britain). This reduced level of protection may have adverse consequences also in the case of multi-tiered holding structures, since for British companies the personal entitlement to relief is reduced and any shareholders behind them are no longer able to claim their own entitlement to relief.
Conversely, dividends of British companies will continue to be subject to national (section 8b (1), (4), (5) German Corporation Tax Act (Körperschaftssteuergesetz – KStG)) and DTC intercorporate privilege (Article 23 (1)(a) DTC Great Britain), but here, too, the protection conferred by the Parent-Subsidiary Directive would cease to apply. For that reason, the more stringent activity requirements of the DTC (Article 23 (1)(c) DTC Great Britain) and of the German Trade Tax Act (Gewerbesteuergesetz – GewStG) (section 9 no. 7 sentence 1, sentence 4 ff. of the GewStG) would have to be met in order to claim exemption from German trade tax.
b) Interest and Royalties Directive no longer applicable
In individual cases, the end to the Interest and Royalties Directive is likely to bring disadvantages, for example if a British company is a common parent to the debtor and creditor company and the DTC here does not result in exemption from withholding tax for interest/royalties.
c) Merger Directive no longer applicable
Upon the end of the Britain’s membership in the EU/EEA, numerous restructuring measures will no longer enjoy protection by the Merger Directive, nor will it be possible any longer to take these on a tax-neutral basis in accordance with the German Reorganisation Tax Act (Umwandlungssteuergesetz – UmwStG)). That means that, for example, a British corporation would no longer be able to transform (contribute) its German production facility to a subsidiary on a tax-neutral basis. It may therefore make sense for operational reasons to perform any required restructuring measures prior to the effective date of Great Britain’s EU exit.
d) Add-back taxation
Upon the end of EU/EEA membership, there will be the risk of add-back taxation in Germany for passive income of British companies unless the low taxation threshold is significantly reduced by then. Whereas hitherto it has normally been possible to invoke the actual economic activity within the meaning of section 8 (2) of the Foreign Transaction Tax Act (Außensteuergesetz – AStG), this protection will no longer apply when EU/EEA membership ends. As a result, e.g., interest income and most types of royalty income would become subject to add-back taxation, even if the British subsidiary pursues other commercial activities.
e) Relocation of corporations
The relocation of a corporation to another EU/EEA country merely results in disjunction (Entstrickung) pursuant to section 12 (1) German Corporation Tax Act (German Corporation Tax Act (Körperschaftssteuergesetz – KStG) according to which economic assets, in the case of the loss or restriction of German taxation right, are deemed sold at fair market value. In the case of a relocation – discontinuation of unlimited corporation tax liability or change in domicile under the provisions of the convention – to a third country, however, the corporation is deemed to have been dissolved, and section 11 KStG is to be applied analogously with the consequence of all hidden reserves subject to taxation in German being taxed.
f) Drop in exchange rate of British pound
As expected, the Brexit vote has resulted in a significant drop in the exchange rate of the British pound to the euro. Should this drop in the exchange rate continue, that will raise the question of whether this will have tax consequences for corresponding foreign currency liabilities and receivables. Liabilities in pound sterling in this case would see a fall in value and thus result in unrealised profits which are not taxed.
In the case of receivables in pound sterling, the question that would be raised is whether for tax purposes a profit-reducing write-down to fair value (Teilwertabschreibung) is possible. This would require the probable existence of a permanent impairment. Whether that exists will depend on the circumstances of the individual case and particularly on the residual term of the respective receivable. For example, where there is a residual term of ten years it may be assumed that the fluctuation in the exchange rate will rebalance, with the result that no probable permanent impairment exists; however, it appears doubtful whether this can be applied to the hitherto unprecedented case of an exit from the EU. In the case of receivables with shorter residual terms, the conditions for a write-down to fair value (Teilwertabschreibung) can be met, with the result that, subject to section 8b (3) sentence 4 ff. KStG the impairment is tax deductible.
g) Natural persons
Natural persons may also be affected in many different ways. One of the numerous conceivable scenarios is the fictitious unlimited tax liability (fiktive unbeschränkte Steuerpflicht) pursuant to section 1a EStG, the deduction for donations pursuant to section 10b (1) EStG, the exit tax pursuant to section 6 AStG (in future: immediately due instead of interest-free deferral), as well as the preferential treatment given to EU/EEA business assets in German inheritance tax.
2. Transfer prices
The restructuring measures to be expected in the wake of Brexit also have to be assessed in terms of transfer prices. On the basis of the OECD Transfer Pricing Guidelines, the realistically available options of the group entities concerned are to be examined in a first step. In a second step it has to be clarified whether, among third entities at arm’s length, compensation would have been paid, on the merits and on quantum, for the loss of activities previously performed. Assuming that customs duties were re-introduced: for companies with production activities in Great Britain having their main sales territory in continental Europe, a shift in production to continental Europe would be inevitable in the context of price competition and otherwise globally identical cost structures. Despite the lack of alternatives to the shift in production, the second analysis step does not become obsolete. It would be conceivable that the European group companies would enter into competition amongst themselves and would be prepared to make a payment to the British corporation for the transfer of production.
In the case of permanent establishments it has to be examined whether the transfer of economic assets to Germany results in those assets becoming subject to taxation (Verstrickungstatbestand) within the meaning of section 4 (1) sentence 8 half-sentence 2 EStG or whether changes in business procedures lead to an attribution of assets resulting in a dealing within the meaning of section 16 (1) no. 1 of the German Regulation on Profit Allocation to Permanent Establishments (Betriebsstättengewinnaufteilungsverordnung – BsGaV).
The EU Arbitration Convention, which is established as a multilateral treaty, should also remain in force after a Brexit. Moreover, the DTC Great Britain, in its version as amended on 30 December 2010, provides in Article 26(5) for an independent arbitration clause, with the result that complete abolishment of double taxation in UK-German transfer pricing matters continues to be safeguarded.
3. Indirect taxes/foreign trade law
Brexit will also have a noticeable impact on the movement of goods between Germany and Great Britain in several respects. How exactly the specific changes will play out, however, will depend to a decisive extent on the intensity of the later relations between Great Britain and the EU. Great Britain might e.g. become an EEA member, an EFTA member (European Free Trade Association) or a party to a preferential agreement. A relationship without preferences/benefits is also conceivable.
VAT treatment of cross-border flows of goods between the EU and Great Britain will change. The common VAT regime, as the basis in Union law hitherto in force, will no longer be applicable to Great Britain. What are now tax-exempt intra-Community supplies from and intra-Community aquisitions in the EU will then turn into imports and exports. These changes in VAT assessment will require adjustments in the companies’ accounting systems and in the reporting of turnovers in VAT declarations. Any changes in registration requirements in Great Britain should also be examined.
b) Customs duties
With its leave the EU, Great Britain will also presumably withdraw from the Customs Union. For the import of goods from Great Britain, therefore, customs law – as with all third countries – will have to be applied. What have hitherto been transfers within the Internal Market will turn into imports and exports with relevance for customs regulations. That might result in the levying of customs duties on (certain) goods. The extent to which that will happen, however, will depend on the future relationship with the EU in terms of trade policy. At any event, duties on imports in the EU will make it much more expensive to acquire or supply goods from Great Britain. As a mirror image to this, the export of goods to Great Britain is also expected to be subjected to duties (in Great Britain). In the calculation of origin it has to be noted that British goods will presumably no longer qualify as EU goods. Calculations of customs value will also have to be reviewed since i.a. add-back criteria will then also apply to Great Britain as a third country (e.g. licences from Great Britain for import goods).
c) Excise taxes
The cross-border transport of goods subject to excise taxes will also no longer be possible on the basis of the common excise tax regime under Union law. It will no longer be possible for the IT process EMCS to apply to the entire transport from and to Great Britain. Instead, the provisions of the import and export process under customs law in conjunction with excise tax criteria will have to be applied.
d) Foreign trade law
In the area of foreign trade law, supplies to Great Britain presumably will no longer be qualified as transfers but instead as exports. It is true that past transfers in some cases were already relevant for export controls, but the expenditure with regard to the possible authorisation requirements will rise as a result of their qualification as exports.
VI. Legal impact
1. Employment law/residency law
In the medium-to-long term, Brexit could also give rise to consequences for German companies in the area of employment and residency law. These are likely to include in particular impacts relating to a restriction or even elimination of free movement for workers. That might make it more difficult in future for a German company operating in Great Britain to gain access to skilled labour. Things will also be more difficult for companies when it comes to secondments and short-term foreign assignments in Great Britain.
Based on unanimous statements made by British politicians in the Brexit campaign, all EU citizens already exercising a profession in Great Britain at the time of its withdrawal from the EU are to enjoy grandfathering protection in the event of the free movement of workers being restricted or eliminated. However, considerable legal uncertainty exists for those EU citizens intending to exercise an activity in Great Britain only in future. It may turn out that they will no longer enjoy the unrestricted free movement of workers and might have to meet the conditions applicable in Great Britain at the decisive point in time – which as things now stand are set to be tightened as at 1 April 2017.
As a result, German employers in future should carefully review whether their non-British candidates/applicants qualify for naturalisation according to the respective residency provisions in force or expected to be in force in Great Britain. If this is not the case, employers concerned should prepare themselves by taking appropriate organisational measures to ensure that visas, residence permits and employment permit papers can be obtained within a short time for any non-British employees working in Great Britain whom they intend to hire.
The same considerations and precautions should be made by German companies in respect to their British employees working in Germany. Here, too, it is not yet foreseeable what impact the withdrawal of Great Britain from the EU will have on residency law.
Moreover, there is legal uncertainty in respect of the future practicability of cross-border transfers of business. After the exit of Great Britain from the EU, British rules on transfers of business might be repealed or – in a substantially unforeseeable way – revised, in which case on the one hand the process of cross-border transfers of business might be impeded and/or slowed and on the other it might become necessary to take account of hitherto unforeseeable consequences of such measures.
2. Financial supervisory law
Loss of the status of Member State of the European Union and the possible non-participation in the EEA mean that companies having their seat in Great Britain will no longer be able to use the hitherto available “European passports”. “European passports” enable companies, on the basis of a qualified authorisation in their home country, to operate in all Member States of the EEA subject to only a low level of residual supervision in the respective host country, whether through branches or by way of cross-border services. These provisions apply on the basis of the EU directives for insurance undertakings, investment services enterprises, management companies and credit institutions.
The end to the option of using the “European passports” will have the following consequences: companies having their principal establishment in the UK will no longer be able to operate via the “European passport”, and thus will have to either discontinue the activity (case 1), continue their activity as a branch of a third country (case 2) or use a subsidiary in a Member State holding the required authorisation (case 3).
The same considerations apply to the product side for which “European passports” were also introduced. UCITS funds and AIFM funds, for example, or also insurance policies, may be marketed throughout the EEA solely on the basis of a home country prospectus and a home country authorisation. The same thing applies to other securities whose prospectus could be designed on the basis of the Prospectus Directive implemented in the respective Member States. In addition to the treatment of “new products” after the exit from the EU, the question raised is how the exit will impact the admissibility of the distribution of “old products”, i.e. those issued during Great Britain’s membership of the EU. [more on the European Passport]
3. Corporate law
In Germany, Brexit will not be without consequences for corporate law: for example, consequences for British companies in Germany are conceivable, but also for cross-border transformation deals and transnational legal forms.
English limited companies and other British corporate forms – such as limited liability partnerships (LLP) – having their administrative seat in Germany face considerable legal uncertainty. Based on the freedom of establishment laid down in Articles 49, 54 TFEU and the foundation theory applied by the ECJ, the national law provisions of EU-foreign corporations, e.g. relating to limitation of liability or on legal capacity, are also recognised by German courts. However, in absence of EU-influence German courts typically determine the status of companies operating in Germany based on the so-called seat theory. If the administrative seat is in Germany, a company must satisfy the requirements of German law for it to, e.g., claim liability law privileges. A British company having its administrative seat in Germany might, post-Brexit, be classified by the German courts as a personally liable partnership (Offene Handelsgesellschaft, OHG), or a civil law partnership (Gesellschaft bürgerlichen Rechts, GbR). The shareholders would then have to assume personal liability for obligations of the company. It is still unclear to what extent a kind of grandfathering might be recognised for already existing British companies in Germany.
Furthermore, cross-border mergers pursuant to section 122a et seq. of the German Transformation Act (Umwandlungsgesetz – UmwG) involving British companies might become impossible since these are also premised on EU/EEA membership. Cross-border changes in company form having a reference to Great Britain would also be affected.
Legal forms such as the European company (SE) or the European Cooperative Society (SCE) are affected if they have their seat in Great Britain. In this case it will likely be necessary to move the seat or effect a change in legal form.
4. Data protection
A withdrawal of Great Britain from the EU will likewise lead to changes in the general conditions particularly relating to the transfer of personal data to Great Britain. That is because Great Britain, after its exit from the EU, will have to be qualified as a “third country” within the meaning of the EU General Data Protection Regulation (EU GDPR). That means that the transfer of data from the EU to Great Britain – also within a company group – in future will require justified grounds (ensuring a reasonable level of data protection). Pursuant to Article 44 ff. EU GDPR, this is based on an adequacy decision of the EU Commission as exists e.g. for Canada, Switzerland, New Zealand and Israel, or an international agreement, similar to the planned EU-US Privacy Shield. It is currently not foreseeable whether such justification grounds will be established in future. For that reason, potentially affected companies should prepare themselves to base data transfers to Great Britain, at least temporarily, on other mechanisms such as binding corporate rules, EU standard data protection clauses or approved standard clauses or to move the relevant data processing operations to the EU.
5. Trade mark and patent law
For traditional “European patents” prescribing a uniform application and grant procedure before the European Patent Office (which is not an EU institution) for a bundle of national patents, no material changes are to be expected. However, the package adopted for a unitary EU patent and an EU patent jurisdiction (with a sub-division planned in London) adopted after considerable political wrangling in 2013 will be affected to a lasting extent by Brexit. This particularly holds true since the entry into force of the unitary EU patent is dependent on the introduction of EU patent courts but the EU Agreement on a Unified Patent Court to date has not yet been ratified by Great Britain and it is hardly conceivable that this will still happen after the referendum.
Without any separate provisions on their conceivable continued application from the date of the concluded Brexit, Union trade marks will no longer enjoy any protection on British territory. To avoid any potential gaps here, companies should consider at an early stage whether to apply for a national trade mark.
6. Regulatory law
Given the pronounced level of integration of the regulated markets existing in some areas, it is not likely that the British market will soon decouple from the EU resulting in high market entry barriers. A complete disintegration, e.g. of the energy markets, is hard to imagine given the existing constructive dependencies, particularly in the area of electricity. Nonetheless, “special approaches” might very well lead to a decoupling of the British market in the medium to long term.
On leaving the EU, Great Britain will cease to be a member of the Internal Energy Market. However, the provisions regulating network operation (unbundling, network access, market access, etc.) adopted from the internal market directives (3rd EU Internal Market Package of 13 July 2009) initially will essentially not change fundamentally.
Directly applicable secondary law, such as the Natural Gas Access Regulation (EC) No 715/2009, the Access to Exchanges in Electricity Regulation (EC) No 714/2009 and the Regulation on wholesale energy market integrity and transparency (REMIT) No 1227/2011, would no longer be applicable as of the effective date of withdrawal.
Great Britain would moreover “leave” the Energy Community with immediate effect since the Treaty establishing the Energy Community of 25 October 2005 was ratified only by the EU. Essentially, the objective pursued with the Energy Community is to expand the rules of the Internal Energy Market to a certain extent also to non-EU countries (referred to as acquis communitaire). Given the fact that Norway and also Switzerland did not join the Energy Community, it is well likely that Great Britain will not rejoin the Energy Community.
In the exit negotiations, one particular subject of discussion is likely to be Great Britain’s role in the EEA. Irrespective of that, Great Britain, in addition to the rules of the World Trade Organization, is also bound i.a. by the Energy Charter and the Paris Agreement (post-Kyoto convention).
The Energy Charter Treaty no doubt gives companies a certain measure of security with regard to the investments they have already made and are planning. But this does not shield them from regulatory intervention. Although Great Britain moreover would no longer be required to participate in European energy trade, it would nonetheless still be bound by the obligation to cut its CO2 emissions under the UNFCC, and in particular by the post-Kyoto Protocol “Paris Agreement” of 12 December 2015. In this context, Great Britain initially is not expected to fundamentally change its legal framework on avoiding CO2 emissions.
1. 48.1% of votes cast were for remaining in the EU, 51.9% for leaving it.
2. Cf. Thiele, Europarecht, 2016, p 298.
3. Thiele, op cit. (fn 2), p 299.
4. In addition to EU parent companies, particularly US companies (Article 10(3), Article 28 DTC USA) and in future also certain Japanese parent companies (Article 10(3) DTC Japan 2015) also come to mind which in each case would have a claim to the zero rate.
5. Cf. section 20 UmwStG in conjunction with section 1 (3) no 4, (4) no. 2 UmwStG.
6. Cf. also Busch, DB 2015 p. 1548.
7. Cf. paragraph 9.59 ff. of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, OECD, Paris 2010 (OECD Transfer Pricing Guidelines).
8. With regard to the concept, cf. Haentjens/Gioia-Carabellese, European banking and financial law, London/New York 2015 p. 99 ff; Hanten, ZBB 2000 p. 245.
– On Brexit as a taxation criterion in Germany, cf. Bron, DB1204504;
– On Grexit and Brexit from the viewpoint of transfer pricing, cf. Busch, DB 2015 p. 1548 = DB0702317.
This article was published in German language in "Der Betrieb", DB dated 08.07.2016, no. 26-27, page 1526 - 1530, DB1208809: "Scheiden tut weh: Der Brexit und die steuerlichen und rechtlichen Folgen"
Dr. Oliver Busch | Transfer Pricing
Dietmar Gegusch | Tax Politics
Dr. Alexander Linn | Income Tax
Bettina Mertgen | Customs/VAT
Dr. Fariba Peykan | FSI Tax
Klaus Gresbrand | Corporate/M&A
Dr. Mathias Hanten | Banking & Finance
Dr. Söntje Julia Hilberg | IT
Dr. Julia Sierig | Employment
Dr. Florian A. Wesche | Energy
Stefan Wilke | IP